Experienced options trading investors use a variety of options strategies to maximize profit potential and minimize risk. These are some basic options strategies that emphasize reducing risk.
The long call option strategy is easily the most basic option trading strategy whereby the options trader buys call options with the belief that the price of the underlying security will rise significantly beyond the strike price before the option expiration date. The maximum loss for a long call option strategy is limited to the cost of the premium and commissions paid for the call option.
A call spread is an options strategy in which equal quantity of call option contracts are purchased and sold simultaneously on the same underlying security but with different strike prices or expiration dates. Call spreads limit investor’s maximum loss but it also limits the potential profit.
A butterfly options trading strategy could use either call or put options. A long call butterfly spread is made of three legs with a total of four options. The four options for the butterfly strategy with call options include a long one call with a lower strike, short two calls with a middle strike, and a long one call with a higher strike price. All the options used for a butterfly spread have the same expiry.
The middle strike price is halfway between the lower and higher strike prices. The position is recognized as long due to the fact the butterfly spread entails a net cash outlay. The potential gain is higher than the potential loss, but both the potential gain and loss are limited if the butterfly spread is done correctly.
Hedging in financial investments is the use of methods to reduce risk. A put hedge or protective put is when the investors buy put options to protect the stocks they own. This strategy for options trading is also called a synthetic long call.
Buying an index straddle involves buying an index call and an index put on the same underlying index. For a straddle, both options have the same strike price and expiration month. A long straddle position is typically purchased and sold as a package with both options bought and sold at the same time to either realize a profit or cut a loss.
Provided that both call and put options are held, an investor is hedged. The bullish call potentially increases in value with a rise in the underlying index and the bearish put increases with a decrease in the index level. The index straddle strategy is used when the investor expects a major change in the index but is uncertain of the direction of the change.
The married put is an option strategy when the options trader buys an at-the-money put option and buys an equivalent number of shares of the underlying stock. A married put strategy is frequently used when the investor is bullish on a stock, wants to own the stock, but is worried about the stock’s performance.
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