With fixed maturities of 12 months or more, buying call options is the most profitable, which makes sense since long-term call options benefit from an unlimited rise and a slow fall in time. The most profitable option strategy is to sell put and call options out of the money. This trading strategy allows you to collect large amounts of options premium while reducing your risk at the same time. Traders implementing this strategy can achieve approximately 40% annual returns.
Here are 10 options strategies every investor should know. With calls, one strategy is simply to buy a simple call option. You can also structure a so-called basic cover or buy and write. This is a very popular strategy because it generates income and reduces some risk of going long on stocks alone.
The tradeoff is that you must be willing to sell your shares at a fixed price (the short strike price). To execute the strategy, you buy the underlying shares as you normally would and simultaneously write or sell a call option on those same stocks. On the P&L chart above, the dashed line is the long position of the stocks. With long put and long stock positions combined, you can see that as the stock price falls, losses are limited.
However, the stock may participate in the hike above the premium spent on the sale. The P&L graph of a married sale is similar to the P&L graph of a long call. In a bullish buy spread strategy, an investor simultaneously buys calls at a specific strike price and, at the same time, sells the same call number at a higher strike price. Both call options will have the same expiration date and the same underlying asset.
On the P&L chart above, you can see that this is a bullish strategy. For this strategy to execute correctly, the trader needs the stocks to increase in price to make a profit on the trade. The disadvantage of a bullish buy spread is that its advantage is limited (even if the amount spent on the premium is reduced). When direct calls are expensive, one way to compensate for the higher premium is to sell higher strike calls against you.
This is how you build a bullish call spread. The bearish sell spread strategy is another form of vertical spread. In this strategy, the investor simultaneously buys put options at a specific strike price and also sells the same number of put options at a lower strike price. Both options are bought for the same underlying asset and have the same expiration date.
This strategy is used when the trader has bearish sentiment about the underlying asset and expects the price of the asset to decline. The strategy offers limited profit and loss. On the P&L chart above, you can see that this is a bearish strategy. For this strategy to be successfully executed, the stock price must fall.
When using a bearish sell spread, your advantage is limited, but your premium spent is reduced. If direct put options are expensive, one way to compensate for the high premium is to sell lower exercise put options against you. This is how you build a bearish sell spread. A protective collar strategy is carried out by buying an out-of-the-money (OTM) put option and, simultaneously, issuing an OTM call option (of the same maturity) when you already own the underlying asset.
Investors often use this strategy after a long position in a stock has seen substantial gains. This allows investors to have downward protection, since the long put option helps to set the potential ask price. However, the downside is that they may be forced to sell shares at a higher price, thus giving up the possibility of making more profits. In the P&L chart above, you can see that the protective collar is a mixture of a so-called cover and a long sell.
This is a neutral trading setup, which means that the investor is protected in the event of a stock crash. Compensation is potentially required to sell the shares long in the short strike. However, the investor is likely to be happy to do so because they have already experienced gains on the underlying stocks. A “long straddle” option strategy occurs when an investor simultaneously buys a call and put option on the same underlying asset with the same strike price and expiration date.
An investor usually uses this strategy when they believe that the price of the underlying asset will move significantly outside a specific range, but they are not sure which direction the movement will take. The main advantage of buying LEAPS is that your maximum loss is limited to the amount of premium you pay. Most risk-averse traders love the ability to control stocks without spending thousands on their purchase and the defined risk profile of the trade. This strategy works well with non-dividend NASDAQ and Russell 2000 growth stocks that would otherwise scare away risk-averse traders due to their wild price swings.
The Buy Ratio Back Spread is one of the simplest options trading strategies and this strategy is implemented when one is very bullish on a stock or index. In general, the most profitable option strategy is to sell put options. It's a bit limited, as it works best in a rising market. Even selling ITM offers for very long-term contracts (6 months or more) can generate excellent returns due to the effect of falling time, whatever the way the market turns.
Selling credit spreads leverages both rising and falling market trends. Margin requirements are smaller, making it easier for the smaller investor to start. Even Iron Condors (basically two opposing credit spreads) see good returns in a stagnant market. A calendar spread involves buying (selling) options with an expiration and simultaneously selling (buying) options on the same underlying at a different maturity.
A butterfly spread is one of the neutral options trading strategies that combines bullish and bearish spreads, with fixed risk and limited profit. Short traddles, short bottlenecks and long butterflies benefit in such cases, where the premiums received for writing the options will be maximized if the options expire worthless (e). The apportionment will offset the premium paid because the premium of the sold option will be deducted from the premium of the purchased option. Options traders, on the other hand, realize that a profit can be made in any environment, even when the market is not trading up or down.
Here's a simple test to assess your risk tolerance and determine if it's better to be an option buyer or an options writer. But if you look at advanced options traders, they generally treat options as a hedging instrument or as a strategy instrument, where the goal is to maximize profits and minimize losses. A synthetic buy is one of the options trading strategies used by those traders who have a long-term bullish view of the stock, but who are also concerned about downside risks at the same time. Use options to negotiate one-off events, such as corporate restructurings and spin-offs, and recurring events, such as earnings releases.
Call options give the holder the right, but not the obligation, to buy the underlying shares, while put options give the owner the right, but not the obligation, to sell the underlying shares at a predetermined price within a set maturity period. If a stock traded in a wide range and calms down, or vice versa, options can gain or lose value with no net gain or loss in stock price. So, we've seen bullish and bearish options trading strategies, but what about the ones that don't have a stance? There are always a lot of people who don't see a clear, one-sided direction in the short term and want not to be affected by it. Synthetic put is one of the options trading strategies that is implemented when investors have a bearish view of the stock and are concerned about the potential short-term strength of that stock.
The answer to those questions will give you an idea of your risk tolerance and whether you are better off being an option buyer or an options writer. Too often, traders try to trade options without understanding the various strategies available to them. . .