Wednesday, June 23rd, 2021

Effective Options Trading Strategies


There are two reasons to trade stocks options. One is to protect a position against loss. The other is to make money from stock price changes in the market. There are effective options trading strategies to accomplish these goals.

Effective Options Trading Strategies

Covered Puts
Covered Calls
Long Straddle

Effective Options Trading Strategies: Covered Puts

When you purchased a stock that has gone up in price you may be tempted to sell but are unsure because you do not want to miss out on further gains. But, the market is volatile and your gains are at risk. In this case it may be wise to buy puts on your stock.

A specific example of when to buy puts is when an investor has gotten into a growth stock early and has seen a spectacular run up in stock price. He is concerned that the market has overshot on the stock price and is due for a correction. However, the stock keeps going up and he does not want to lose out on more gains. So, he does not sell the stock but he buys puts on the stock. When the stock price goes up, he exits the position at the lower price by executing the opposite trade. He buys puts at that price. Then he purchases puts again at the new, higher price. This is a real example of when to buy puts that saved any number of investors during the dot com bubble a decade ago.

Effective Options Trading Strategies: Covered Calls

A nice way to add a little income on top of stock dividends is by selling call options on stocks that you own. This is called a covered call option.

A covered call option is when the owner of stock writes an options contract obligating him or her to sell stock at the contract price, the strike price, at a future date, the expiration date, if the buyer so chooses. The buyer of a call option pays a premium to have the option but not the obligation to buy stock in blocks of 100 shares per contract. The seller of a covered call option, or uncovered call option, is obligated to sell if the buyer exercises the contract. This sort of occasional options trading is fairly free of risk and profitable.

This is an effective options trading strategy when you are familiar with the price movement of your stock and are certain that the price will not suddenly rise, in which case you would lose out on gains. But, when the stock reliably trades within a predictable range this is a good way to make a little extra money from time to time and continue to hold the stock in question.

Effective Options Trading Strategies: Long Straddle

A third effective strategy applicable to a volatile market is the long straddle.

A long straddle is buying both a call and a put on the same stock with the same expiration date. In a long straddle options strategy the worst a trader can do is lose the cost the premiums paid for the call and the if the stock does not change price. However, this options trading strategy has potentially unlimited potential if the stock price changes significantly.

The long straddle does not require that you own the stock in question. Your protection comes from two things. You will gain if the price of the stock rises or falls. And, if the stock price does not budge, the worst result is that you have paid two premiums for the call and for the put.

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