What do investors need to know before choosing an option strategy? Options are conditional derivative contracts used for speculating or hedging that let risk-tolerant holders buy or sell a security at a chosen price, based on the underlying assets – which could be stocks, indexes, , or commodities. With a call option, buyers purchase the right to buy the underlying asset in the future at a predetermined (exercise or strike) price. With a put option, the buyer purchases the right to sell the underlying asset in the future at a predetermined price.
If market prices are unfavorable for option holders, they can let the worthless option expire, taking a loss for less than the premium paid upfront. On the other hand, if the market is moving upward, you have the opportunity to trade contracts with leveraging power and potentially score profits. The 6th Avenue Team can talk you through options and help you get started if it is deemed to be appropriate for you and your goals.
Options Trading Strategies for Beginners
· Buying (Long) Calls – Bullish traders who are confident in a particular stock, ETF, or index can limit risk, utilize leverage, and take advantage of increasing prices by purchasing long calls. By trading options rather than the underlying asset, smaller amounts are risked. The loss is limited to the premium paid, while the profit is virtually unlimited as the payoff increased with the underlying asset price until the expiration date.
· Buying (Long) Puts – Bearish traders who are uncertain on a particular stock, ETF, or index can limit risk, utilize leverage, and take advantage of falling prices by purchasing long puts. Opposite of the call option, the put gains value as the price of the underlying asset decreases – much like short-selling, though the risk is lower because the option simply expires worthless if the underlying asset rises past the option’s strike price. Maximum profits are also capped since the underlying price cannot dip below zero, but the put option leverages returns much like the long call option.
· Covered Call Writing – Covered call writing involves using stock you already own to offer someone else the right to buy your stock at a specified price. When you sell your call, the premium collected lowers the cost basis on the shares to provide downside protection. By selling the option, you agree to sell shares at the option’s strike price, which caps your potential profits. The cash premium is yours to keep, but overall profits are limited. You may still lose money if the stock declines in price. Choose this strategy if you expect little to no increase in the underlying asset’s price and if you’re willing to limit some of your gains in exchange for protection.
· Cash-Secured Naked Put Writing – By selling a put option on a stock you want to own with a strike price you’re willing to pay for stock, you receive a cash premium for accepting an obligation to buy stock at the strike price. You can still opt out of buying the stock, keeping the premium no matter what. If you buy shares, you will be cash-secured.
· Protective Put – A protective put allows you to be bullish in the long run, but protective in the short-term. If the underlying price increases above the put’s maturity strike price, the option expires worthless and you’ll lose the premium, but still benefit from the underlying increase. If the underlying price decreases, your portfolio loses value, but your losses are covered by the put option gain.
This is a great strategy if you want to own the underlying asset, but achieve some downside protection too – much like a deductible insurance policy.
· Collar – Conservative investors will find limited profits, but limited losses by seeking a covered call position. With this options trading strategy, you hold shares of an underlying stock, while simultaneously buying protective puts AND selling call options against your holding. In a manner of speaking, your put acts as an insurance policy limiting your losses to a minimum, but adjustable, amount.
· Credit Spread – A more bullish credit spread options strategy involves the purchase of one call option and the sale of another, while a more bearish credit spread strategy involves the purchase of one put option and the sale of another. Both options have the same expiration. As an investor, you collect cash for the trade. Higher priced options are sold, while less expensive options are bought. As with most beginner strategies, the profits are limited, but so are the losses.
· Iron Condor – This option consists of two vertical spreads – one call credit spread and one put credit spread – with the same expiration and four different strikes. Gains and losses are limited.
· Double Diagonal Spread – Like the Iron Condor, you will benefit from two vertical spreads at the same time, though the expiration and strike prices are different. You have a long-term straddle and a short-term strangle. The Double Diagonal consists of a diagonal bull call spread with a diagonal bear put spread. At first, you may profit from minimum volatility in the underlying security, but once the initial options expire you can earn maximum profits if the stock price is equal to the strike price of the short option or if the stock price is equal to the strike price of the straddle on the expiration date. It is essential to open and close at “good prices” and trade a large quantity of spreads so the commission is as low as possible. Therefore, this strategy is a little more advanced than the others discussed.
If you wish to pursue options strategies, you can find options listed on registered exchanges with certain minimum requirements for trading directly – much like shares. For this reason, most people trade via a broker. When you trade options with the 6th Avenue Team, you’ll deal on our platform and we’ll execute your orders on the exchange. Contact us to learn more about this exciting opportunity and other investment strategies.
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