Let us analyse the lottery model, where we gamble on a lottery ticket with minimal odds of winning. But if we win, we win big. Similarly, when we trade-in options, we know there is a measure of risk, yet we nevertheless engage in the expectation of a jackpot. However, skilled options traders regard options as a hedging or strategizing tool, with the objective of maximising gains while limiting losses. That’s the ideal situation!
In reality, there is a certain option trading strategy that is meant to reduce risk and maximise returns. This article will describe 7 such option trading methods that every trader should know.
- Bull Call Spread:
A bull call spread involves buying one At-The-Money (ATM) call option and selling the other. Notably, both calls must have the same underlying stock and expiration date.
When the underlying stock price rises, the approach makes money, and when it falls, the strategy loses money. Net Debit = Premium Paid minus Premium Received for a lower strike. The Spread is the difference between the two strike prices.
- Bull Put Spread:
This is a bullish options trading strategy that traders can use when they are optimistic on the underlying asset’s movement.
Unlike the bull call spread, we buy puts instead of calls. Buying 1 OTM put option and selling 1 ITM put option.
- Bear Call Spread:
The Bear Call Spread is a 2-leg option trading strategy used by traders who are ‘moderately negative’ on the market.
This approach comprises purchasing 1 OTM Call option and selling 1 ITM Call option. Notably, both calls must have the same underlying stock and expiration date.
- Call Ratio Back Spread:
The Call Ratio Back Spread has been one of the easiest option trading techniques and is used when a company or index is highly bullish.
Traders can make infinite gains when the market rises and restricted profits when the market falls. The trader loses only if the market stays inside a range. Traders can benefit in either way of the market.
- Synthetic Call:
A Synthetic Call is also one of the option trading techniques employed by traders who are long-term optimistic but also concerned about negative risks. That’s a lot of money for a little risk.
The approach entails buying put options on the stock we own and are positive on. If the underlying price rises, we benefit, but if it falls, we just lose the premium paid for the put option. This method is comparable to Protective Put.
- Synthetic Put:
Synthetic put is an option trading strategy used when investors are concerned about the stock’s near-term strength.
This approach is known as the synthetic long put since it profits from a decrease in the underlying stock’s price.
- Long & Short Strangles:
The strangle is identical to the straddle, but requires us to buy call and put options at the ATM strike price, whereas the strangle requires us to acquire OTM call and put options.
Buying one OTM put and one OTM call option. Profit is infinite, and loss is restricted to the net premium flow.
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