Wednesday, September 23rd, 2020

Short Options Trading Strategy

December 11, 2009 by T.D. Thompson  
Filed under Options Trading Tips


In short options trading you can execute a short call option in which you promise to sell a stock at a given price if the buyer so chooses. In this case you do not own the stock and really hope that the stock does not go up in value. If the stock does not go up and the buyer does not exercise the option then you gain the value of the premium on the option. If the stock has a really good run you stand to loose the difference between the strike price when the option contract was made and the spot price where the market is when the option is exercised. Buying a short put option gives you the right to sell a stock that you do not own, at the strike price if you choose. If the stock drops in value you will buy the stock at the lower spot price and sell at the higher strike price. Your profit will be the difference in prices minus the cost of buying the put.

Short selling is selling assets that you have borrowed from a third party. The way this works is that you borrow shares from a broker and then sell them at the current market value. Your hope is that the stock will decrease in value so that you can buy the shares for less. Your profit is the difference between the original price and what you sell the shares for, minus the cost of borrowing and commissions. Short options trading is similar except that you need not borrow the stock. In options trading the either buy or sell a right to buy shares. The leverage in options trading can therefore be more substantial than in non options trading.

In buying a short when you do not own the stock the only risk is that the stock does not move in value or goes up in price. Then you will not exercise the option and you will lose the premium that you paid. This is a strategy that anyone can use as the potential options trading loss is limited.

In short selling a put in options trading you run the risk of a substantial loss if the stock price goes up substantially. This is an options trading strategy for the more experienced trader who believes that a stock will go down in value. In all options trading one needs to keep in touch with the market so that if the fundamentals of the stock or the market change appreciably one can get out of the position and cut one’s losses.

A prime advantage in a short options trading strategy is that it can be carried out with less capital. The leverage allows a trader who anticipates a substantial drop in a stock price to profit by buying a put and allows a trader who correctly predicts that a stock will not move or will go down to profit repeatedly on selling call options. The safer and potentially more lucrative options trading strategy is to buy puts, but only if you are correct often enough to make money because you do need to pay the premium with each contract.

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