What is an Options Trading Strategy?

In options trading, a trading strategy involves establishing more than one position on the underlying stock and possibly holding the stock itself. An options trading strategy is used to reduce risk or to increase the chance of gain in options trading. One options trading strategy is buying both a put and a call on the same stock with the same expiration date at the same strike price, which allows you to gain if the stock price is volatile, whether it goes up or down. This is called a long straddle.

When you buy the right the buy stock any time before the end of the options contract you are buying a call. When you buy the right to sell the stock any time before the end of the trading contract you are buying a put. The value of a call increases as the value of the underlying stock goes up and the value of a put increases as the value of the underlying stock goes down.

A neutral or “non directional” options trading strategy is to “bet” on the movement of the underlying stock, whether up or down does not matter. The long straddle options trading strategy works well in very volatile markets. It works better in the American options trading system than in the European options trading system because in the American options trading system one can exercise the option at the ideal time whereas in the European options trading system one can only exercise the option at the end of the options contract.

The only risk in using a long straddle as your options trading strategy is that the stock will not go up or down. Then you will have paid premiums for both the call and the put. This is opposed to a short straddle where you sell both a call and a put, pocket the premiums and hope that the stock does not move. In this options trading strategy you can lose substantially if the stock moves substantially in either direction.

A long straddle can also be used when you own the stock. A typical example is when a stock has had an excellent run and the owner 1) wants to insure against a large correction of the stock price and 2) wants to be able to buy more stock at the current price if the stock continues to appreciate rapidly. In each case the person using the long straddle will be able to buy (exercise the call option) or sell (exercise the put option) at the strike price (exercise price) even when the spot price (market price) is substantially higher or lower.

In using the long straddle the person is never going to lose more than the price of two premiums and has the potential to gain substantially. If the person already owns the stock this may mean protecting previous gains in a stock or allowing the purchase of more stock at a discount. In this case the hedging that a long straddle allows is an insurance policy in the form of an options trading strategy.