Options strategies
Encyclopedia
Options strategies can favor movements in the underlying that are bullish, bearish or neutral. In the case of neutral strategies, they can be further classified into those that are bullish on volatility and those that are bearish on volatility. The option positions used can be long
and/or short positions in calls
.
The most bullish of options trading strategies is the simple call buying strategy used by most novice options traders.
Stocks seldom go up by leaps and bounds. Moderately bullish options traders usually set a target price for the bull run and utilize bull spreads to reduce cost. (It does not reduce risk because the options can still expire worthless.) While maximum profit is capped for these strategies, they usually cost less to employ for a given nominal amount of exposure. The bull call spread and the bull put spread are common examples of moderately bullish strategies.
Mildly bullish trading strategies are options strategies that make money as long as the underlying stock price does not go down by the option's expiration date. These strategies may provide a small downside protection as well. Writing out-of-the-money
covered calls is a good example of such a strategy.
The most bearish of options trading strategies is the simple put buying strategy utilized by most novice options traders.
Stock prices only occasionally make steep downward moves. Moderately bearish options traders usually set a target price for the expected decline and utilize bear spreads to reduce cost. While maximum profit is capped for these strategies, they usually cost less to employ. The bear call spread and the bear put spread are common examples of moderately bearish strategies.
Mildly bearish trading strategies are options strategies that make money as long as the underlying stock price does not go up by the options expiration date. These strategies may provide a small upside protection as well. In general, bearish strategies yield less profit with less risk of loss.
Examples of neutral strategies are:
, long condor and long butterfly.
Long (finance)
In finance, a long position in a security, such as a stock or a bond, or equivalently to be long in a security, means the holder of the position owns the security and will profit if the price of the security goes up. Going long is the more conventional practice of investing and is contrasted with...
and/or short positions in calls
Call option
A call option, often simply labeled a "call", is a financial contract between two parties, the buyer and the seller of this type of option. The buyer of the call option has the right, but not the obligation to buy an agreed quantity of a particular commodity or financial instrument from the seller...
Bullish strategies
Bullish options strategies are employed when the options trader expects the underlying stock price to move upwards. It is necessary to assess how high the stock price can go and the time frame in which the rally will occur in order to select the optimum trading strategyTrading strategy
In finance, a trading strategy is a predefined set of rules for making trading decisions.Traders, investment firms and fund managers use a trading strategy to help make wiser investment decisions and help eliminate the emotional aspect of trading. A trading strategy is governed by a set of rules...
.
The most bullish of options trading strategies is the simple call buying strategy used by most novice options traders.
Stocks seldom go up by leaps and bounds. Moderately bullish options traders usually set a target price for the bull run and utilize bull spreads to reduce cost. (It does not reduce risk because the options can still expire worthless.) While maximum profit is capped for these strategies, they usually cost less to employ for a given nominal amount of exposure. The bull call spread and the bull put spread are common examples of moderately bullish strategies.
Mildly bullish trading strategies are options strategies that make money as long as the underlying stock price does not go down by the option's expiration date. These strategies may provide a small downside protection as well. Writing out-of-the-money
Moneyness
In finance, moneyness is a measure of the degree to which a derivative is likely to have positive monetary value at its expiration, in the risk-neutral measure. It can be measured in percentage probability, or in standard deviations....
covered calls is a good example of such a strategy.
Bearish strategies
Bearish options strategies are employed when the options trader expects the underlying stock price to move downwards. It is necessary to assess how low the stock price can go and the time frame in which the decline will happen in order to select the optimum trading strategy.The most bearish of options trading strategies is the simple put buying strategy utilized by most novice options traders.
Stock prices only occasionally make steep downward moves. Moderately bearish options traders usually set a target price for the expected decline and utilize bear spreads to reduce cost. While maximum profit is capped for these strategies, they usually cost less to employ. The bear call spread and the bear put spread are common examples of moderately bearish strategies.
Mildly bearish trading strategies are options strategies that make money as long as the underlying stock price does not go up by the options expiration date. These strategies may provide a small upside protection as well. In general, bearish strategies yield less profit with less risk of loss.
Neutral or non-directional strategies
Neutral strategies in options trading are employed when the options trader does not know whether the underlying stock price will rise or fall. Also known as non-directional strategies, they are so named because the potential to profit does not depend on whether the underlying stock price will go upwards or downwards. Rather, the correct neutral strategy to employ depends on the expected volatility of the underlying stock price.Examples of neutral strategies are:
- Guts - sell in the money put and call
- ButterflyButterfly (options)In finance, a butterfly is a limited risk, non-directional options strategy that is designed to have a large probability of earning a small limited profit when the future volatility of the underlying is expected to be different from the implied volatility....
- buy in the money and out of the money call, sell two at the money calls, or vice versa - StraddleStraddleIn finance, a straddle is an investment strategy involving the purchase or sale of particular option derivatives that allows the holder to profit based on how much the price of the underlying security moves, regardless of the direction of price movement...
- holding a position in both a call and put with the same strike price and expiration. If the options have been bought, the holder has a long straddle. If the options were sold, the holder has a short straddle. The long straddle is profitable if the underlying stock changes value in a significant way, either higher or lower. The short straddle is profitable when there is no such significant move. - StrangleStrangle (options)In finance, a strangle is an investment strategy involving the purchase or sale of particular option derivatives that allows the holder to profit based on how much the price of the underlying security moves, with relatively minimal exposure to the direction of price movement...
- the simultaneous buying or selling of out-of-the-money put and an out-of-the-money call, with the same expirations. Similar to the straddle, but with different strike prices. - Risk ReversalRisk reversal-Risk Reversal investment strategy:A risk-reversal consists of being long an out of the money call and being short an out of the money put, both with the same maturity....
Bullish on volatility
Neutral trading strategies that are bullish on volatility profit when the underlying stock price experiences big moves upwards or downwards. They include the long straddle, long strangle, short condor and short butterfly.Bearish on volatility
Neutral trading strategies that are bearish on volatility profit when the underlying stock price experiences little or no movement. Such strategies include the short straddle, short strangle, ratio spreadsRatio spread
Ratio-spread is a strategy in options trading that involves buying some number of options and selling a larger number of other options of the same underlying market and the same expiration date, but of a different strike price....
, long condor and long butterfly.