Having the right option trading strategy plays a huge role in determining success in options trading. With the right trading strategies, you can mitigate risks, generate profits and navigate different market conditions. This blog highlights five trading strategies you can use as a beginner in options trading. Let’s start.
What is Option Trading?
Before getting into the nitty-gritty of stock strategy in options trading, let’s understand what options trading means. An option forms one-half of futures and options trading, where you have the right to buy or sell a stock, commodity, exchange-traded fund (ETF) or currency at a predetermined price in the future.
Unlike futures, where both parties need to mandatorily execute the contract at expiry, options do not have any such obligations. You can or can not execute the agreement if it does not suit you or meet your needs.
5 Options Trading Strategies for Beginners
Here are five option trading strategies that you can use as per your choice:
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Covered Call Strategy
A covered call is one of the most widely used stock strategy options traders use. If you own stocks of a particular company and seek to generate some extra income, you can use this strategy. In this strategy, you allow someone else to buy your stock at a certain price within a certain time frame.
This price is called the strike price and in return you get a premium. If the stock price does not go above the strike price, you can keep the stock and the premium. Let us understand it with the help of an example.
Suppose you have 100 shares of a stock trading at ₹100 each. You sell a call option at a strike price of ₹110 and receive a premium of ₹5 per share. If the stock price does not go above ₹110, not only you keep the shares but also the ₹500 earned as premium.
While this share market strategy of options trading can help you earn an extra income, do note that it can limit your profits if the stock price rises significantly.
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Long Call Strategy
A long call strategy is a widely used trading strategy in option trading. In this strategy, you buy a call option to gain the right to buy a stock at a certain price in the future. You can use the long call strategy when you strongly feel the stock price will increase. Though you pay a premium, if the stock price goes beyond the strike price, you can exercise the call option. In the process, you buy the stock at a low cost. Let us understand this strategy with an example.
Suppose a company’s stock is currently trading at ₹1000 per share. You feel its price will go up in the next month, and you buy a call option at a strike price of ₹1050. You pay a premium of ₹20 per share. If the stock price rises to ₹1100 at the expiration date, you make a profit of ₹30 per share. On the other hand, if the price falls below the strike price, your losses are limited only to the premiums paid.
The long call strategy has unlimited profit potential if prices increase. However, if multiple trades go wrong, you can also incur losses.
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Long Put Strategy
The long put strategy is another stock trading strategy options traders use. In this strategy, you buy a put option. The put option gives you the right to sell a stock at a certain price in the future. Contrary to the long call strategy, this strategy is ideal if you expect the stock price to decline. Suppose a company’s stock is trading at ₹500 per share.
Because of some negative news, you feel its price will decline in the future. You buy a put option at a strike price of ₹480 by paying a premium of ₹10 per share. If the price drops to ₹450 at expiration, you make a profit of ₹20 per share. On the other hand, if prices rise, your losses are limited only to the premiums paid.
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Short Put Strategy
A short put options strategy involves selling a put option. By doing so, you essentially agree to purchase the stock at the strike price if its cost goes below that level before option expiry. Let us understand this with an example. Suppose shares of a certain company are trading at ₹100, and you are willing to buy them even if there is a price drop.
You sell a put option with a strike price of ₹90 and receive a premium of ₹5 per share. If the stock price stays above ₹90, the entire premium received by you is your profit. However, you must buy the shares if the stock price falls below ₹90. However, since you have a premium of ₹5, your effective purchase price will be lower.
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Married Put
This common option trading strategy acts like insurance to protect your investment. Here, you buy a stock and purchase a put option for it simultaneously. Suppose you buy 100 shares of an enterprise at ₹100 per share.
To safeguard your investment, you also get a put option at a strike price of ₹90 and pay a premium of ₹5 per share. With this, you have 100 shares of the company and also the right to sell them if their prices drop below ₹90.
If stock prices go up, you do not need to exercise the put option. You can sell the shares at a higher price and make profits. On the other hand, if the price falls to ₹80, you can sell the stock at ₹90 using the put option. Thus, it helps you limit your losses.
How to Choose Option Strategy?
Before choosing any of the above trading strategies, you need to open Demat account and start options trading. Before picking any of these, it is vital for you to thoroughly understand option trading and have an understanding of market dynamics.
You can choose any of these strategies once you are clear on them and your goals. Remember, the best strategy for option trading is the one that helps you accomplish your goals.
In Conclusion
With the right share strategy, you can script success in the fast-paced world of option trading. If you want to venture into the world of share market and learn about different trading strategies, you can download the HDFC Sky App
This share market app helps you invest in a range of financial instruments like stocks and mutual funds. You can get insightful pieces on share market strategies that can help you reap success in the long run.