Options trading has a market mystique around it. Many believe options trading to be inherently risky or overly complex. The options trading market is also poised for disruption through new technology and assets, making it quite intimidating.
However, while trading options successfully does take a bit of education and some practice, anyone can learn the fundamentals to trade properly.
Today, let’s break down five ways to trade options so you can play smart and avoid losses for your portfolio.
The first options strategy you can employ is called the long call. In a nutshell, you purchase an option and “go long,” meaning that you wager that the stock underlying the option will go above the strike price by its expiration date.
There are lots of positives and minuses to this options strategy. If you time your call well enough by looking at trading signals, your potential profit is unlimited until the strike price expires. If the stock price goes the other way, you can simply sell the call before the expiration date. On the downside, though, you risk losing your entire premium.
Use a long call if you’re looking to earn far more profit on a stock’s price increase compared to purchasing the stock normally. It’s also a good choice if you have a high risk tolerance level and don’t mind wagering the entire premium on one option purchase.
A covered call is an options strategy that’s a little more complex than the abovementioned ones. First, you have to own the underlying stock. Then, you have to sell a call contract on the same stock you own. You get a premium payment and give away all the appreciation for the stock above the strike price.
In essence, you bet the stock will stay flat or decrease just a little in price until the expiration date. As the call seller, you can pocket the premium and keep ownership of the stock. Because this strategy relies on a stock behaving exactly as you predict, it’s considered a complex options strategy and only recommended for advanced options traders.
Your maximum upside is the premium you use for the covered call. Remember that as a stock’s price goes above the strike price, your option becomes more costly, which can offset any of the games you received from the premium. Consider using this strategy if you want to generate income while limiting your risk and expect the underlying stock to stay flat or decrease in price until the expiration time.
Then there’s the long put: the opposite and equal option strategy compared to the long call. With this option trade, you wager that a stock’s price will decrease instead of increase, essentially betting that the stock will be below the strike price by the expiration time.
Your long put contract is theoretically worth the most if the target stock’s price hits $0 per share, but your exact profit will depend on the difference between the stock and the option strike price at the time of expiration or when your position closes. The good news is that even if the stock price rises, you can sell the put and save some of your premium, provided you do so before the expiration time. The worst that can happen is that you lose your premium completely.
Consider using the long put option strategy if you believe a stock will decline radically in the near future. You’ll earn much more money by owning successful put options compared to short-selling practically any stock on the market. Furthermore, short selling has no limit to your risk, so it could be a good way to limit or minimize your potential losses while still leaving some room for profits.
A short put is an options strategy where you purchase a put contract with the intention of selling it. This is called “going short.” You wager that the underlying stock will either stay flat or rise in price until the expiration time based on your fundamental analysis.
Why use this option strategy? Because you can use it to generate income by selling the premium money to other investors who want to bet that the same stock will fall in price. Thus, it’s something of an unorthodox strategy that relies on you understanding human behavior patterns just as much as the underlying market. If you don’t understand human behavior (and your emotions), you’re already committing a fundamental trading mistake.
Keep in mind that you should only sell your puts sparingly. Remember, you are on the hook to purchase shares if the underlying stock goes below the strike price at the expiration time, which can seriously affect your bottom line and overall portfolio health.
Last is the married put, a sophisticated options trading strategy. It essentially combines ownership of an underlying stock with a long put (thus marrying the two trades).
Here’s how it works. For every 100 shares you own of a specific stock, you purchase one put contract. In doing this, you can keep owning the stocks for appreciation while also hedging your bets in case the stock prices fall. This is somewhat like purchasing insurance for your stocks in that you have to pay a premium to protect your portfolio against asset decline.
You should only use married put trades to hedge your portfolio against market risk. If you’ve already made excellent games, you can use the married put strategy to profit from continued stock appreciation and protect those gains.
Theoretically, you can keep owning a stock that rises in price with a married put, and your potential gain is infinite. Even if a stock decreases in price, you only have to pay the premium, which effectively caps your potential losses.
As you can see, there are many ways to trade options successfully. Try to implement these strategies the next time you place an options order and see how they work for your portfolio goals.