How to options strategies

How to options strategies

Why use it: If you’re not concerned about losing the entire premium, a long call is a way to wager on a stock rising and to earn much more profit than if you owned the stock directly. It can also be a way to limit the risk of owning the stock directly. For example, some traders might use a long call rather than owning a comparable number of shares of stock because it gives them upside while limiting their downside to just the call 8767 s cost — versus the much higher expense of owning the stock — if they worry a stock might fall in the interim.

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In the P& L graph above, notice how there are two breakeven points. This strategy becomes profitable when the stock makes a very large move in one direction or the other. Again, the investor doesn’t care which direction the stock moves, only that it is a greater move than the total premium the investor paid for the structure.

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A protective put is a long put, like the strategy we discussed above however, the goal, as the name implies, is downside protection versus attempting to profit from a downside move. If a trader owns shares that he or she is bullish on in the long run but wants to protect against a decline in the short run, they may purchase a protective put. 

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In simple terms, you sell a put option on a stock you want to own by selecting a strike price that represents the price that you are willing to pay for that particular stock. So, your aim is to get allocated or to acquire the stock below the current/today market price.

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Investors can also use a covered call to receive a better sell price for a stock, selling calls at an attractive higher strike price, at which they’d be happy to sell the stock. For example, with XYZ stock at $55, an investor could sell a call with a $65 strike price for $7, then:

By sorting each strategy into buckets covering each potential combination of these three variables, you can create a handy reference guide. You could even print it out and tape it to your wall. Doing so might help you run through the process of making speedy trading decisions should you need or if warranted.

The trader can set the strike price below the current price to reduce premium payment at the expense of decreasing downside protection. This can be thought of as deductible insurance. Suppose, for example, that an investor buys 6,555 shares of Coca-Cola ( KO ) at a price of $99 and wants to protect the investment from adverse price movements over the next two months. The following put options are available:

In the P& L graph above, notice how the maximum gain is made when the stock remains unchanged up until expiration (right at the ATM strike). The further away the stock moves from the ATM strikes, the greater the negative change in P& L. Maximum loss occurs when the stock settles at the lower strike or below, or if the stock settles at or above the higher strike call. This strategy has both limited upside and limited downside.

Those with an interest in this strategy could consider looking for OTM options that have a high probability of expiring worthless and high return on capital. Capital requirements are higher for high-priced stocks lower for low-priced stocks. Account size may determine whether you can do the trade or not. Many traders may look for expiration in the short premium “sweet spot,” typically between 75 and 55 days out, depending on the level of implied volatility, upcoming news or company announcements, among other factors. Targeting the sweet spot aims to balance growing positive time decay with still-high extrinsic value. Choose a stock you’re comfortable owning if the stock drops and short put is assigned. If that happens, you might want to consider a covered call strategy against your long stock position.

Therefore, the higher priced option is sold and cheap, a further out-of-the-money option is bought. It is a strategy with market bias and limited profits as well as losses. A call spread is usually bearish, and the put spread is bullish. An example is to buy 5 JNJ Jul 65 calls and sell 5 JNJ Jul 55 calls.

A credit spread is one of the best income strategies using options. With credit spread strategy, you purchase of one call option and then sell another. An alternative, it involves the purchase of one put option, and sell off another. In this scenario, both options have the same expiration. The reason why it is termed as a credit spread is that the investor collects cash for the options trading.

Be sure to understand all risks involved with each strategy, including commission costs, before attempting to place any trade. Clients must consider all relevant risk factors, including their own personal financial situations, before trading.

In this example we are using a call option on a stock, which represents 655 shares of stock per call option. For every 655 shares of stock you buy, you simultaneously sell 6 call option against it. It is referred to as a covered call because in the event that a stock rockets higher in price, your short call is covered by the long stock position. Investors might use this strategy when they have a short-term position in the stock and a neutral opinion on its direction. They might be looking to generate income (through the sale of the call  premium ), or protect against a potential decline in the underlying stock’s value.

If the price of the underlying increases and is above the put s strike price at maturity , the option expires worthless and the trader loses the premium but still has the benefit of the increased underlying price. On the other hand, if the underlying price decreases, the trader’s portfolio position loses value, but this loss is largely covered by the gain from the put option position. Hence, the position can effectively be thought of as an insurance strategy.

Another best options strategy for monthly income is the cash-secured naked put writing strategy. It is a strategy that entails writing an out-of-the-money or at-the-money put option and at the same time setting aside sufficient cash to buy the stock.

Potential upside/downside: If the call is well-timed, the upside on a long call is theoretically infinite, until the expiration, as long as the stock moves higher. Even if the stock moves the wrong way, traders often can salvage some of the premium by selling the call before expiration. The downside is a complete loss of the premium paid — $555 in this example.

The  bear put spread  strategy is another form of vertical spread. In this strategy, the investor will simultaneously purchase put options at a specific strike price and sell the same number of puts at a lower strike price. Both options would be for the same underlying asset and have the same expiration date. This strategy is used when the trader is bearish and expects the underlying asset s price to decline. It offers both limited losses and limited gains.

In the P& L graph above, you can see that this is a bullish strategy, so the trader needs the stock to increase in price in order to make a profit on the trade. The trade-off when putting on a bull call spread is that your upside is limited, while your premium spent is reduced. If outright calls are expensive, one way to offset the higher premium is by selling higher strike calls against them. This is how a bull call spread is constructed.

Combination of a short OTM call vertical and long at-the-money (ATM) or slightly OTM call butterfly. This should be a credit spread, where the credit from the short vertical offsets the debit of the butterfly. This is not aggressively bearish, as max profit is achieved if stock is at short strike of embedded butterfly. But if an unbalanced call butterfly is initiated for a credit, it should not lose money if the stock drops and the options in the position expires worthless.

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