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The Best Options Trading Strategies

Even if you’re new to options trading, you’re probably already familiar with buying puts and calls. These are the two most basic options strategies and the ones that rookie options traders gravitate to. That makes sense. Puts and calls are low-risk and easy to understand. Buy a put and you want the underlying security to go down in value. Purchase a call and you’re cheering for the underlying security to rise. Either way, your risk exposure is limited to the premium you pay to buy the contract. If the contract expires worthless, you lose nothing more than the cost of the contract.

To that end, we’re definitely fans of buying puts and calls, no matter what your level of options experience is. The potential for explosive returns without the need for betting the farm on each trade is unrivaled in the investing world. But we’re also fans of broadening our horizons and investing in options is one of the best places to do this. With so many different options strategies, there’s literally always a way to make a profit. Let’s look at the top 7 options strategies.

Long Call: Simply buy a call option on a stock. This provides unlimited upside potential and caps the associated risks at the amount paid for the stock option. For Example, say you have $1600 and think Google (GOOG) will increase in value: say it is currently trading at $500 a share but you only have enough money to buy 3 shares. Instead of buying the shares you decide to buy call options on Google (GOOG). Let’s say you want to be conservative and only buy options trading write at the money (strike of $500). Now you just need to choose the expiration month (do you think the stock will increase in value soon or will it take a while?) Say you believe Google (GOOG) will increase in value within 1 month. You buy September 500 Calls for $16 (you have $1000 so you can afford 1 contract (sold in 100 board lots). As long as Google (GOOG) Trades at $516 at expiration in September you have made a profit.

Say GOOG is trading at $550 at the expiration of the call options:

If you had bought 3 shares your profit would be ($550-500) *3 = $150.

If you bought the Call Options your profit would be {(550-500)-16} *100 = $3400.

Put Writing (Short Put): Simply sell put options on a stock. This provides you with the option premium while your maximum risk is the strike price of the option minus the premium received. Your max risk scenario would only occur if the price of the stock went to $0. For this strategy an investor will normally have a neutral to bullish market forecast. Say you are interested in Apple (AAPL) and think it will appreciate in value or remain the same. You can sell Puts on Apple (AAPL) and received the option premium in exchange for the risk that the stock may decrease in value up to the expiration of the stock options you sell. Say Apple (AAPL) is trading at $120. To be conservative you write put options with a strike price at the money ($120) for $6 each and an expiry in 1 month. Say you only write 1 contract, you will receive $600. While you are waiting for the option to expire you can invest that $600 elsewhere say in Google. At expiry, as long as the Apple (AAPL) is trading above (120 – 6 = $114) you have made a profit.

Married Put: This strategy is implemented by buying the stock and buying a put on the stock. This provides you with protection against a price decline while you can still participate in all upside in the stock price. The risk/reward profile is very similar to the Long Call; that’s why this strategy is also referred to as a ‘synthetic call.’ Lets go with Starbucks (SBUX). You buy 100 shares at $25 a piece for $2500 and want to protect yourself against a decline in Starbuck’s (SBUX) stock price so you buy puts right at the money because you are being very conservative. Say you only want to protect your stock from a decline for 1 month. You buy puts with a strike of $25 1 month to expiration for say $1. Now, the most money you can loose over the month is the $1 you paid for the put while you still can participate in any upside so as long as the Starbucks (SBUX) is trading above $26 at expiration you have made a profit.

Call Writing: Simply Write (Sell) call options on a stock. This provides you with the option premium while your maximum risk is infinite (the stock can potentially increase to infinity). For this strategy an investor will normally have a neutral to bearish market forecast. Say you are interested in Apple (AAPL) and think that it will depreciate in value over the next month or remain the same. You can sell Call options on Apple (AAPL) and receive the option premium in exchange for the risk that the stock may increase in value over the month. Say Apple (AAPL) is trading at $120 and you are going to be conservative and write put options with a strike price at the money ($120). You receive $5 in premium. As long as the price of Apple (AAPL) is less than (120 + 5 = $125) at expiration, you have made a profit.

Short Straddle: This strategy is implemented by simultaneously writing a put and a call option on the same stock with the same strike price and the same expiration date. This way, as long as the stock price remains somewhat stable you will profit. For example, say Google (GOOG) is trading at $500 and you think it will remain near that price over the next month: sell Google (GOOG) $500 Calls for $16 and sell Google (GOOG) $500 Puts for $15, both with expirations of about 1 month. As long as the price of Google (GOOG) at expiration in one month is trading above ($500 – (15 + 16) = $469) and below ($500 + (15 + 16) = $531) you have made a profit.

Short Combination (Short Strangle): This strategy is similar to the Short Straddle as you write a call and a put option; however, the difference is that with a short combination you use different strike prices. This way you can increase your window of profit opportunity just incase there is a price move. For example, say Apple (AAPL) is trading at $120/share and you think the price will remain somewhat stable over the next month but are a bit more causes than the Short Straddle Investor: sell Apple (AAPL) $130 Calls for $2 and sell Apple 110 (AAPL) Puts for $3; both with one month to expiration. As long as the Apple Shares remain above (110 – 3 – 2 = $105) and below (130 + 3 + 2 = $135) you have made a profit. This way you will receive less option premium but are more likely to make a profit.

Long Straddle: This strategy is the opposite of the Short Straddle; an investor will simultaneously buy a call option and a put option on the same stock with the same strike price and same expiration date. Investors use this strategy when they think a large price more will occur in a stock but are unsure of which direction the stock will move. This strategy can work well when a major anticipated decision is about to be made for the stock: buy-back program, law suite, new technology, earnings reports, presidential election. For example, say the United States Presidential Election will occur in the next month and you want to find a way to profit. Some stocks will move depending on which candidate wins and you decide to focus on Starbucks (SBUX). Say one candidate wants to increase taxes on milk and the other wants to decrease them. You know this will effect Starbucks (SBUX) bottom line so you decide to implement a long straddle because you are not sure which candidate will win. You buy calls and puts with the same strike price on Starbucks (SBUX) and same expiration month. When the decision is announce the stock will most likely move dramatically in one direction. As long as the stock moves in one direction more than the amount that you paid in option premium you will profit.

Time Spreads (Calendar Spreads): This strategy is implemented by buying and writing an equal number puts or calls on the same stock with different expiration dates but the same strike prices. Normally time spreads have a neutral basis, but they can also be designed for a bullish or bearish basis. For example, sell $500 Calls on Google (GOOG) with 1 month to expiration and buy $500 Calls on Google (GOOG) with 6 months to expiration. You can make a profit if the Calls with a shorter time to expiration erode in value faster than the longer term calls. This tends to work as the time value component of an option’s value, usually erodes faster the shorter the term to expire. However, you need to consider other aspects of the options price like volatility.

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