Best option trading strategies
It's possible to make money through simply buying options with a view to selling them later at a profit, and indeed some investors do generate profits in this way. The real money, though, is generally made by those that know how to employ different strategies and use the appropriate options spreads in any particular situation.
Successful options trading isn't necessarily just a case of forecasting which way you think the price of an underlying security move and then trading the relevant options accordingly. Your aim should really be to maximize your profits based on the amount of capital you have to invest and the amount of risk you wish to take. To achieve this, you not only need to have a decent understanding of the different strategies you can use, but you also should know the different factors that you need to be considering when deciding which ones to use and when.
We offer detailed advice on this subject on the following page; Choosing the Right Options Trading Strategy. We have also devised a very effective tool that you can use to help choose the right strategy based on certain criteria. You can find this tool here.
In addition, we have a simple alphabetical list of all the strategies we cover on our A-Z List. These are options spreads that are used to generate profits when the price of an underlying security rises. Because of this, you would use them if you were anticipating an upward movement in the price of a financial instrument. Please visit this page for more information, including a detailed list of strategies that fall into this category. These are essentially the opposite of bullish strategies.
They are used to profit from a downward move in the price of an underlying security, so you generally be advised to use them if you expected to see the price of a financial instrument fall. For more details on this category, and a list of the relevant strategies, please click here.
The main advantage of buying calls is that your profits are theoretically unlimited, because you continue to profit the more the price of the underlying security rises. The biggest sacrifice that you make with most bullish trading strategies is that the potential profits you can make are limited to a certain amount.
However, given that most options trades are based on relatively short term price movements, and financial instruments don't frequently move in price by huge amounts; this isn't necessarily a major drawback. Another disadvantage is the added complication of trying to choose the right strategy. The concept of buying calls is by itself relatively simple. If you think a financial instrument is going to increase in price, then you can benefit from that increase with a straightforward transaction.
Complicating matters by trying to maximize your potential profits or limit your potential losses obviously involves more time and effort.
You'll typically pay higher commissions too, because most strategies require multiple transactions to create spreads. However, overall you are far more likely to be consistently successful when trading options if you get to know all about the different trading strategies and learn which ones to use and when. The following is a list of the most commonly used strategies that are appropriate for a bullish outlook. We have included some brief information about each one, including how many transactions are involved, whether a debit or credit spread is created and whether or not the it's suitable for a beginner.
For more detailed information on each strategy, such as how to use it, its advantages, and it's disadvantages, simply click on the relevant link. For more assistance in choosing a suitable trading strategy you may like to use our Selection Tool for Options Trading Strategies.
This is a single position strategy that involves only one transaction. It's suitable for beginners and comes with an upfront cost. Only one transaction is required for this, and it produces an upfront credit. It isn't suitable for beginners.
This is a simple strategy suitable for beginners. It involves two transactions to create a debit spread. This is straightforward but it's not really suitable for beginners because of the trading level required. A credit spread is created using two transactions. This is complex and requires two transactions; as such it isn't suitable for beginners. Options trading has two big advantages over almost every other form of trading. One is the ability to generate profits when you predict a financial instrument will be relatively stable in price, and the second is the ability to make money when you believe that a financial instrument is volatile.
When a stock or another security is volatile it means that a large price swing is likely, but it's difficult to predict in which direction. By using volatile options trading strategies, it's possible to make trades where you will profit providing an underlying security moves significantly in price, regardless of which direction it moves in.
There are many scenarios that can lead to a financial instrument being volatile. For example, a company may be about to release its financial reports or announce some other big news, either of which probably lead to its stock being volatile. Rumors of an impending takeover could have the same effect. What this means is that there are usually plenty of opportunities to make profits through using volatile options trading strategies.
On this page, we look at the concept of such strategies in more detail and provide a comprehensive list of strategies in this category. Quite simply, volatile options trading strategies are designed specifically to make profits from stocks or other securities that are likely to experience a dramatic price movement, without having to predict in which direction that price movement will be. Given that making a judgment about which direction the price of a volatile security will move in is very difficult, it's clear why such they can be useful.
There are also known as dual directional strategies, because they can make profits from price movements in either direction. The basic principle of using them is that you combine multiple positions that have unlimited potential profits but limited losses so that you will make a profit providing the underlying security moves far in enough in one direction or the other.
The simplest example of this in practice is the long straddle, which combines buying an equal amount of call options and put options on the same underlying security with the same strike price.
Buying call options a long call has limited losses, the amount you spend on them, but unlimited potential gains as you can make as much as price of the underlying security goes up by. Buying put options a long put also has limited losses and almost unlimited gains.
The potential gains are limited only by the amount which the price of the underlying security can fall by i. By combining these two positions together into one overall position, you should make a return whichever direction the underlying security moves in. The idea is that if the underlying security goes up, you make more profit from the long call than you lose from the long put. If the underlying security goes down, then you make more profit from the long put than you lose from the long call.
Of course, this isn't without its risks. If the price of the underlying security goes up, but not by enough to make the long call profits greater than the long put losses, then you'll lose money. Equally, if the price of the underlying security goes down, but not by enough so the long put profits are greater than the long call losses, then you will also lose money. Basically, small price moves aren't enough to make profits from this, or any other, volatile strategy.
To reiterate, strategies of this type should only be used when you are expecting an underlying security to move significantly in price. Below is a list of the volatile options trading strategies that are most commonly used by options traders. We have included some very basic information about each one here, but you can get more details by clicking on the relevant link.
If you require some extra assistance in choosing which one to use and when, you may find our Selection Tool useful. We have briefly discussed the long straddle above.