Important Options Strategies You Should Know
Options are a type of derivative asset that let buyers to buy or sell an asset at a specific price. Option buyers pay a premium to the sellers to get that right (but it is not an obligation).
Options have two categories, namely, “call” and “put” options. A call option gives the buyer of the contract the right to buy the underlying asset in the future at a specific strike price. Meanwhile, a put option gives the buyer of the contract the right to sell the underlying asset in the future at a specific price.
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The following are some of the most essential options trading strategies you should know about. Read on!
This strategy is used by traders who are bullish or confident that a stock, ETF, or index will rise, but want to protect their upside. Traders also use long call, or buying calls, to use leverage to make the most out of the rising price.
Options are leveraged, meaning they permit traders to magnify the benefit by risking smaller actual amounts.
A trader’s potential loss from this strategy is limited to the amount of premium paid for the contracts. The potential profit will be unlimited since the payoff will increase along with the underlying asset’s price until expiration.
This strategy is popular among traders who are bearish on a stock, ETF, or index, but want to take on less risk.
The put option is similar to the call option except that the contract gains value the more the asset’s price declines.
The potential loss is also limited the price of premium paid, while the maximum profit from the position is limited since the underlying price cannot go below zero.
Traders who anticipate no change or slight increase in underlying prices use this option strategy. They are also often willing to limit their upside in exchange of protecting against losses.
Basically, the trader buys 100 shares of the underlying assets and selling a call option against those shares.
When he or she sells the call, he or she collects the premium, lowering the cost basis on the shares offering some downside protection.
If the underlying price increases above the strike price before expiry, the short call option can be exercised. The trader will have to deliver the shares of the asset at the option’s strike price, even if it is lower than the market price.
Traders who already own the underlying asset but want some downside protection usually use this strategy.
A protective put is very much like a long put. The difference is that the goal is downside protection and not attempting to profit from a downside move.
If the trader owns the shares and the trader is bullish for the long term, he or she may protect the against a downturn in the short term, the protective put is usually helpful.
If the price of the asset stays the same or rises, the potential losses will be limited to the premium, which is given as an insurance.
If, on the other hand, the price of the underlying asset declines, the loss in capital will be offset by an increase in the option’s price. It will be limited to the difference between the initial price and the strike price plus the premium.
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