Options provide a way for investors to benefit from favourable price movements without buying or selling an underlying asset itself. For example, suppose you think that company X’s share price will rise in the future. In that case, this could be seen as a profitable investment strategy rather than purchasing the shares themselves and holding onto them until their value increases. An investor who has purchased stock can now sell it at its current market price (a ‘call’ option) or buy more of it now but leave his right to do so (‘put’ option) until later.
What Strategies Can You Use to Trade Options?
A Long Straddle
This strategy involves a combination of buying a ‘call’ and ‘put’ option with the same strike price and expiration date. When should this strategy be used? This may be an appropriate strategy if you think that the underlying stock’s price will move dramatically, either up or down and want to capture as much profit as possible. Therefore, if you believe that company X’s share price will rise significantly in the future, you could purchase a call option with a strike price of £5 and buy a put option at £5.
Covered Call
The covered call is another popular options trading strategy that can generate profit for investors who want to make money from their stocks without selling them straight away. The investor would buy a stock and sell a call option with a specific strike price. This strategy can be helpful to investors who want to benefit from the rise in prices for their stocks but don’t necessarily want to own them long-term as they still have other investment portfolios.
Cash Secured Put
The cash-secured put is where you simultaneously buy a ‘put option and short-selling shares of the underlying stock. This is not commonly used by individual investors but rather institutional investors such as hedge funds because it requires significant capital and high-risk tolerance. If the share price falls below the agreed-upon price at the options expiration date, the investor would be required to pay out on all shares he had previously sold short.
Collar
This is a protective options strategy that involves writing covered calls and purchasing protective puts simultaneously. This strategy can be helpful for investors that don’t want to see their stock’s value decrease but don’t want to benefit from rising prices because they neither own nor short-sell the underlying asset. For example, if you were an investor who owned company X’s shares during a year when its cost rose by 20%, then you would have made £5,000 on your investment (ignoring brokerage fees). However, if this had fallen by 10%, you would only have lost £2,000 on your investment which may be more appealing than either option alone.
Ratio Spread
A ratio spread is when you buy more of one option than the other when opening a position. This can be done in anticipation that whatever option has been bought will increase in value, but also because the less valuable option will decrease in price or vice versa. For example, if you thought that company X’s share price would either rise or fall significantly in the future, then you could buy ten call options at £5 and purchase only six put options at £5. If the share price rose to £7, then each call would have increased by 33%, whereas each put would have decreased by 25%, meaning that the investor would make 100% on his investment overall, which may be considered an attractive risk-reward profile for this strategy.
Covered Puts
The covered put is a protective options strategy that invests in the underlying stock while selling put options for additional income. This strategy can only be used by investors who are confident that the stock’s price will either remain stable or fall in value, making this appropriate if you are looking to protect an already existing investment rather than make one. For example, suppose you were an investor who purchased 100 shares of company X at £5 each and wanted to sell your position immediately after for whatever reason. In that case, you could simultaneously sell ten puts with a strike price of £5, meaning that if the share price fell below £1 per share, then you would still hold on to your shares.
