While throwing yourself whole hog into the options market means taking in a great deal of information in a short period of time, there are plenty of strategies to use that are likely to improve your returns and reduce your risk as greatly as possible.
Covered call: Also called the buy-write strategy, a covered call involves purchasing an underlying asset while also generating a call on the same asset. In order to ensure this strategy works properly, it is important to create a call based around how much of the underlying asset you own. This strategy is extremely effective if you own a separate position in the short term and feel that the underlying asset is either going to stay the same or decrease in value in the time frame for the option you created. When done properly, it allows you to generate a bonus premium at the very least. Covered calls are an effective strategy when used with index futures, LEAPS and on funds that are traded via an exchange and purchased on a margin.
Married puts: To utilize a married put, the first thing you need to do is purchase a specific amount of an underlying asset before purchasing a put that covers the same amount. This should be one of your go-to strategies if you feel bullish when it comes to the price of the asset in question and are looking for an easy way to minimize losses. The put that you purchased then acts as a price floor that can help prevent a dramatic drop in price. While putting money into an asset that you believe is going to decrease in price dramatically is never recommended, if you already own the underlying asset, then a married put will help minimize future uncertainty.
While a married put isn’t going to be the right choice all of the time, when used sparingly under the right conditions it can be a reliable way to increase your overall success when it comes to options trading. To ensure that it always works out in your favor you are going to want to begin each transaction with a clear understanding of the risk in question. You can then factor in the added costs of a married put compared to the mitigation of that risk to determine if it is worth moving forward. As an added bonus, married puts help mitigate the potential risk related to early options to exercise as it ensures you always have available shares ready and waiting.
Bull call spread: To use this strategy, you will want to start by purchasing a call option at a strike price you believe to be beneficial. You will then want to sell a similar number of calls at a higher strike price. Both calls should have the same underlying asset and the same timeframe. This is a useful strategy to use if you are bullish on the strength of the underlying asset in question and your research indicates that the price is likely to increase in the time frame you have chosen.
This strategy is also known as a vertical credit spread because it has a pair of mismatched legs. Legs that are sold close to the money generate a credit spread that typically contains a net credit along with a positive time value. On the other hand, a debit spread is created with a short option that ends further from the money than when it started. Overall, this strategy is considered a net buy.
Bear put spread: The bear put spread is similar to the bull call spread but is used in opposite circumstances. Specifically, you begin by purchasing a pair of put options, one at a higher strike price and another at a lower strike price. You are going to want to purchase an equal number of each and ensure that they have the same underlying asset and timeframe. This strategy is useful when you feel bearish on the underlying asset in question as it helps you limit your losses if you are incorrect about the way the market is moving. This strategy should be used cautiously, however, as your overall profits are going to be limited to the difference between the two puts you purchased minus the cost of any transaction fees.
The ideal time to use a bear put spread is if you are interested in short selling an underlying asset and using a more common put option doesn’t seem to be the right choice. You will find them useful if you are interested in speculating that prices are on a downward trend and don’t want to invest a larger amount of capital waiting for the worst to happen. When using a bear put spread you are literally planning for the worst while hoping for the best.
Protective collar: To use the protective collar strategy you are going to want to start by purchasing a put option that is currently out of the money. You will then want to write a different call option based on the same underlying asset that is also out of the money. This is an ideal strategy to use when you have a long position on an underlying asset that has seen significant gains in the recent past. Using a protective collar allows you to both ensure the current level of profit while also holding onto the underlying asset in case it continues to increase in value.
Using a protective collar is as simple as placing the contract for the put option you purchased at a strike price that guarantees you hold on to a majority of the profit you have made. After that, you will be able to fund the collar strategy with the call option that you have written, making sure that it relates to a specific Digit. This strategy is a great way to maintain your profits while adding very little to your overall costs. What’s more, it is very easy to ensure that you don’t have to pay any related taxes as you can allow the option to roll over for as long as you deem necessary.
Straddles: The long straddle strategy is most useful after you have already purchased both a put and a call that share the same timeframe, underlying asset and strike price. It is useful if you believe that the price of the underlying asset is going to move significantly in one direction, you just don’t know which direction it is going to be. Putting a long straddle into effect allows you to rest easy as you will see a gain as long as the price starts moving within the time frame you have chosen.
Alternatively, to institute a short straddle, you will want to sell a call and a put with the same timeframe, the same costs and related to the same underlying asset. This will ensure that you make a profit from the premium if you don’t expect the underlying asset to move much in either direction in the specified timeframe. Be aware, however, that the odds of success will decrease proportionally to the amount that the underlying asset moves in the given timeframe.
Long strangle: In order to utilize a long strangle you will want to purchase both a put and a call that use the same underlying asset and share a maturation level. They are also going to need different strike prices. The strike price for the put should be somewhat lower than the price of the call, and both should be at a point out of the money. This is a useful strategy if you expect the underlying asset to move significantly but are unsure of the direction it will take. When used properly, you are virtually guaranteed a profit minus any related costs.
A strangle functions much like a straddle except that it tends to be cheaper as you are purchasing options that are already out of the money. This means you can routinely expect to pay as much as 50 percent less which makes it easier to play both sides of the fence. When given the option, a long strangle is preferable to a short straddle as it offers the chance at twice the premium while forcing you to take on the same amount of risk.
Butterfly spread: A butterfly spread requires the use of a bear spread strategy in addition to a bull strategy and contains three separate strike points. To start you want to purchase a call option at the lowest price you can manage. You will then want to sell two calls at a higher price and a third call at a price that is higher still. Your goal is to ensure a range of potential profits at prices you believe will be profitable. The most effective time to use a butterfly spread is when you have a neutral opinion on the current state of the market.
It is a good idea to utilize a butterfly spread when you expect the underlying asset that you favor to increase in price but are unsure of how much gain to expect. As such, you are going to want to make sure the overall market volatility is as low as possible. The higher the overall level of volatility, the more setting up a butterfly spread will cost you. The butterfly spread is not without a downside, however, as if you are wrong about the direction the underlying asset is going to move in then the losses can be significant.
Iron Condor: In order to use the iron condor strategy, you are going to want to start with a short position and a long position utilizing a pair of ‘strangle’ strategies to take full advantage of a market that is low in volatility. One ‘strangle’ is going to be long and the other short and set to an outer strike price. You can also move forward using two credit spreads. In this case, the call spread would be above the current market price, and the put would be below the current market price.
You are only going to want to attempt the iron condor when trading in index options because they offer a unique mix of increased volatility coupled with a lower increase in risk. Additionally, it is important to put an iron condor into play only when you are extremely confident you know where the market is going. This is because the potential for loss, should you choose poorly, is very great. Assuming all goes according to plan you then stand to make a significant profit assuming the market doesn’t move strongly in one direction or the other.
Iron Butterfly: To start an iron butterfly you want to use either a long or a short straddle and concurrently either purchase or sell a strangle based on the straddle you chose. While similar to a basic butterfly, this strategy utilizes both calls and puts rather than just one or the other. When done properly it limits the potential for profit or loss to the range of the strike prices that you set. This strategy is best used with options that are out of the money as they allow you to minimize both risk and cost.
The pair of options that you use in the iron butterfly should be set at a mid-strike point to generate either a short or a long straddle depending on if you are buying or selling. The so-called wings of the butterfly are formed from the pair of options at the lower strike price and the higher strike price that are generated once the strangle is sold. This helps to offset the long or short position which creates the limits regarding your total profits or losses.