If you intend to trade options as either an insurance policy on underlying stocks you own or as a game unto itself, you need to learn as much as you can about option strategies. Buying calls and puts is pretty straightforward, requiring little more than rudimentary knowledge about options. While participating at that level in a fine endeavor, there are a few other strategies that might be of interest to you. They require a little more sophistication but also offer more opportunities to make money.
It won't take you long to figure out that the best options trading strategy is one that is easy to implement and provides a certain element of protection. The discussion below is going to layout four options trading strategies that check both these boxes. If you can add them to your investing arsenal, you'll find yourself in a good position to make money outside of trading basic securities.
Writing Covered Calls – While this is one of the more basic options strategies, it's also the easiest one to implement. Covered calls are very useful if you own an underlying stock that has recently run up in price and you would like to effectively take advantage of the run up. It could also be useful if a stock you own seems intent on trading in a fairly narrow range over the short-term.
Writing a covered call would require you to agree to sell 100 shares of the underlying stock at a certain strike price by a certain expiration date. The fact you actually own the underlying stock is what makes this a covered call strategy. The best way to use this strategy is to select a strike price that's a bit above the stock's current price while offering a fair amount of premium to put in your pocket. Your downside risk on this strategy would be the stock price far-exceeding the strike price by expiration, forcing you to leave a little profit on the table when the option is exercised. The upside would be the stock price never reaching the strike price, which would result in you keeping all of the premium and your stock.
Bull Call Spread – This strategy is perfectly suited for the investor who is confident in the relative strength of an underlying stock, yet expects moderate stock price movement in the short-term.
To initiate this strategy, you would buy a call or calls at a specific strike price, sell the same number of calls at a higher strike price and do so at the same time. Effectively, you would be limiting your upside potential but also lowering the overall cost of the premium you would pay on the options you bought. The best outcome on this strategy would come if the stock price ran up to a point just under the strike price of the calls you sold.
Protective Collar – This is an excellent strategy to initiate if you are long on an underlying stock that has seen a recent significant run up in price.
This strategy would require that you to purchase an out-of-the-money put option while at the same time write an out-of-the-money call option for the same expiration date. Effectively, you will have put a “collar” on your downside risk at the higher stock price while collecting premium that at worst would require you to sell your long position at a significant price.
Iron Condor – This is a sophisticated strategy you might employ on stocks with low volatility. Your objective would be to accumulate small premiums with limited risk you would find yourself in a losing position.
This strategy would require you to simultaneously buy and sell one out-of-the-money put with the bought option being at a lower strike price (bull put spread). At the same time, you would and buy and sell one out-of-the-money call with the bought call being at a higher strike price (bear call spread). As the stock remains stagnant, there's very little risk.
Ultimately, the best options trading strategy is the one that brings you the best and most consistent profits. The aforementioned strategies are but a few of the strategies you might employ. If interested, you can do some further research on other popular and effective strategies.