How to Use Option Trading Strategies in any Market Situation
Option strategies are implemented by combining one or more option positions and possibly an underlying stock position.
In other words, a trading strategy is a calculated way of using options singly or in a combination, in order to make a profit from market movements.
Option strategies can give you a greater profit with less risk compared with the traditional buying and selling of stock.
One vitally important thing to consider when investing is when to get out and how. An effective exit strategy needs to be decided upon in advance, and stuck to without allowing emotions to sway you.
There are many types of option trading strategies that can be applied, depending on your opinion, or ‘prediction,’ of which direction the underlying stock is going to move.
A guideline for picking the right stocks to go with the right options strategies is available by reading “Options Strategies for Different Stock Styles”. The various stock movements are taken into account – bullish and bearish – as well as major moves, or slower, moderate moves, in either direction - and a strategy that can be applied to each of these movements.
Option strategies are the most versatile instrument in the financial market today, allowing you many opportunities to make a greater profit with a limited risk.
Option strategies can be favorable whether movements in the underlying stock are ‘bullish’ (moving up), ‘bearish’ (moving down), or neutral.
Various strategies can be employed during certain options expiration days, such as when “witching hour” occurs on Triple-Witching Days or ”Quadruple Witching days”, where volume and volatility will be a major factor occurring.
Before you buy or sell options, you need a strategy, which in the long run will meet your investment goals. One of the benefits of options is the flexibility they offer- they can complement your portfolio in any way you wish.
There are many other trading strategies to use with options, some of which are relatively easy to understand and put into practice. Other strategies are more complex and complicated, and their purposes become easier to understand with more experience and knowledge.
With the use of solid trading strategies, options are definitely one of the most dynamic investment vehicles available to traders and investors.
Other Option Trading Strategies
Other Option Trading Strategies
One of the least sophisticated option strategies which can accomplish a market neutral objective with little hassle -- and its effective -- is known as a straddle.
Straddles are an option trading strategy with which the investor holds a position in both a call and put with the same strike price (at-the-money) and expiration date.
With options, you buy a call if you expect the market to go up, and you buy a put if you expect the market to go down. Straddles, however, are strategies to use when you're not sure which way the market will go, but you believe something big will happen in either direction.
A butterfly spread is an option trading strategy combining a bull and bear spread. It uses three strike prices. The lower two strike prices are used in the bull spread, and the higher strike price in the bear spread. Both puts and calls can be used. This strategy has limited risk and limited profit.
Long Call Butterfly Spread
This type of option trading strategy is a conventional butterfly which provides neutral trades, but can be structured with more of a directional tilt by modifying the strike prices involved. The basic structure of a long butterfly is to sell the “body” and buy the “wings.”
The trade has a structure of 1 x 2 x 1. The body of the fly should be centered at whatever your target price is for the stock.
Therefore, in more detail, long butterfly spreads are entered when the investor thinks that the underlying stock will not rise or fall much by expiration. Using calls, the long butterfly can be constructed by buying one lower striking in-the-money call, writing two at-the-money calls and buying another higher striking out-of-the-money call. A resulting net debit is taken to enter the trade.
Maximum profit for the long butterfly spread is attained when the underlying stock price remains unchanged at expiration. At this price, only the lower striking call expires in the money. The formula for calculating maximum profit is given below:
• Max Profit = Strike Price of Short Call - Strike Price of Lower Strike Long Call - Net Premium Paid - Commissions Paid
• Max Profit Achieved When Price of Underlying = Strike Price of Short Calls
Maximum loss for the long butterfly spread is limited to the initial debit taken to enter the trade plus commissions. The formula for calculating maximum loss is given below:
• Max Loss = Net Premium Paid + Commissions Paid
• Max Loss Occurs When Price of Underlying <= Strike Price of Lower Strike Long Call OR Price of Underlying >= Strike Price of Higher Strike Long Call
There are 2 break-even points for the butterfly spread position. The breakeven points can be calculated using the following formulae.
• Upper Breakeven Point = Strike Price of Higher Strike Long Call - Net Premium Paid
• Lower Breakeven Point = Strike Price of Lower Strike Long Call + Net Premium Paid