Options trading is becoming increasingly popular for investors, allowing them to capitalise on an asset’s potential movement without owning it. Various strategies can be used in different market conditions to help traders manage risk while allowing them to benefit from potential gains. This article will discuss some of these options trading strategies, including their advantages and disadvantages, so investors can make informed decisions when considering how best to approach the markets.
The covered call strategy is a popular options trading approach suitable for market conditions in which the investor expects the asset’s price to remain relatively flat. With this strategy, an investor purchases the underlying asset and then sells a call option with the same quantity of shares as collateral. If the market remains stable, the call buyer’s gains from buying the asset will offset their losses from selling the call options.
However, if prices rise, both positions generate can generate returns, although these are likely lower than if they just held onto the purchased assets without writing calls. The risk associated with this approach is that if prices drop significantly, there could be significant losses in both positions.
The long-put strategy is designed for investors who anticipate bearish market conditions. The investor purchases put options and potentially profits if the underlying asset’s price decreases. If prices do drop, the maximum profit potential is unlimited. It will equal the difference between the option’s strike price and the underlying asset’s market value.
This strategy offers protection from losses experienced when an investor holds a stock during a bearish price trend. The risk associated with this approach is that if prices rise instead of fall, there will likely be significant losses due to time decay on the options purchased.
The straddle strategy is suitable for investors who have an opinion on the potential direction of an underlying asset’s price but are unsure which way it will move. The investor purchases a call and put option with the same strike price and expiration date. If prices move significantly in either direction, one of the positions will do well, offsetting any losses from the other position.
This approach can also be used to speculate on market volatility, as returns are made if there is an increase in implied volatility. The risk associated with this strategy is that both options may expire and become worthless if prices remain relatively stable around the strike price of both contracts.
An iron condor is an advanced strategy suitable for investors with a neutral outlook on the underlying asset’s price movement with options trading in Australia. It involves simultaneously buying two out-of-the-money puts and two out-of-the-money calls with different strike prices and the same expiration date. It creates a range of prices within which returns are made if the underlying asset’s price remains steady.
The maximum profit potential is limited since it equals the net premium paid for all four options. The risk is also limited as losses only occur when prices move outside this predetermined range. The iron condor is a popular strategy used to capitalise on traders’ expectations that the underlying asset’s price will remain relatively stable. It is considered a more conservative strategy since it requires less capital than other options strategies, and its structure limits potential losses.
The protective collar strategy is used by investors who own an underlying asset they want to protect against losses while taking advantage of upside potential. With this approach, an investor buys a put option and sells a call option with the same expiration date but different strike prices. It creates a range of prices within which the investor’s losses will be limited, while any gains outside this range will not be capped. The risk associated with this strategy is that if prices move significantly in either direction, there could still be significant losses due to time decay on the options purchased.
Put writing is a strategy suitable for investors who are bullish on an underlying asset’s price and want to take advantage of it. It involves selling put options with a strike price below the current market value of the underlying asset. If prices remain above this level, the investor will receive premiums from selling these puts, which can be used to offset losses elsewhere in their portfolio.
If prices drop below the strike price, the investor may have to purchase the underlying asset at that price, although any losses will be partially offset by the premium received from writing puts. The risk associated with this approach is that if there is significant downward pressure on prices, there could be significant losses due to buying the assets at a higher cost than they would have otherwise.