In today’s world, we all want to make quick money and Options Trading Strategies are very popular to make this happen. But this can be very risky too if we don’t follow certain disciplines and rules when dealing with it. The main important part is to handle the tool properly to make a decent amount consistently.
Stock market is a serious business majorly because it has money involved and professionals with great experience do well in it. Proper learning and understanding of Options Trading strategies become very important to sustain against such experienced professionals.
Making big losses in a single trade is the major obstacle in the success of the stock market. Rather making small profit consistently is the key. In order to achieve this, options trading strategies are a very good choice.
So, let’s learn everything about these options trading strategies right from basics to advance level.
What is Options Trading?
It is a contract between two parties (buyer and seller) used to buy or sell any stock and index. These contracts are made for a certain time frame, it can be set to weekly or monthly.
Why Go for Options? Why Can’t We Buy Stocks Directly?
We can definitely go with the normal stocks, but why it is so emphasized or rather recommended to trade options. Let’s see some of the pointers which will help us to clear out this question.
- Options give us the facility to not pay the complete contract value
- When the market is falling, we can earn money in such scenarios as well, which is not at all possible in the cash market.
- The amount of risk each individual is willing to take is totally up to them to decide and we can earn decent returns.
Types of Options
There are different types of options which are listed below
- Call Options (CE): This gives the rights to the buyers to buy the underlying
- Put Option (PE): This gives the rights to the buyer to sell the underlying
Some Basic Options Trading Terminologies
There are several terms used in the options market few of the important terminology are covered below.
The price which the option buyer has to pay to the option seller is called the option price or the premium. The single unit of the script is the premium traded and we need to multiply the premium with the lot size to reach the total premium in a contract.
E.g. Nifty 10000CE has a premium of 80, so the total premium paid will be, 80 x Lot size i.e. 75 = 6000/-
The price at which the underlying asset trade in the spot market becomes the current price of the stock or the index.
The price per share for which the option holder sells or purchases the underlying security is the Strike or the Exercise price. Selecting the right strike is very important in success of options trading strategies.
In The Money (ITM) Option:
When the spot price is higher than the strike price, then the call option is said to be ITM. Likewise, when the spot price is lower than the strike price, then the put option is said to be ITM. If it is exercised immediately, this option gives the holder a positive cash flow.
At The Money (ATM) Option:
The Strike price is equal to the spot price for both call and put ATM options. This leads to zero cash flow if it is exercised immediately.
Out Of The Money (OTM) Option:
When the spot price is lower than the strike price, the call option is said to be OTM. Similarly, when the spot price is higher than the strike price the put option is said to be OTM.
If it is exercised immediately this option gives the holder a negative cash flow.
The above orange highlighted sentence will be clear after reading the next topic.
All the above terminologies have been put in a tabular format below, please refer it for better understanding.
|In the Money (ITM)||spot price > strike price||spot price < strike price|
|At the Money (ATM)||spot price = strike price||spot price = strike price|
|Out of the Money (OTM)||spot price < strike price||spot price > strike price|
What is Options Pricing?
This can be a little overwhelming topic, but I tried to explain it in a simplistic way. The most important part is to have a clear understanding of the basics of option price calculations. Option premium consists of two components ‐ Intrinsic value and Time value.
The amount by which option is In the Money (ITM) is referred to as intrinsic value. Therefore, only ITM options have intrinsic value, whereas ATM & OTM options have zero intrinsic value. The value of the option can never go negative for intrinsic value.
It is the difference between premium and intrinsic value for ITM options. ATM & OTM options will have only time value because the intrinsic value of such options is zero.
Let’s discuss one example to understand these terms in detail.
Quote for Nifty Call & Put option as on September 09, 2017
|Nifty Spot Price||Type||Strike Price||Call Premium (P)||Intrinsic value (I) |
(Spot Price – Strike Price)
|Time Value for |
ITM (T=P-I) & OTM (T=P)
|Nifty Spot Price||Type||Strike Price||Put Premium (P)||Intrinsic value (I) (Spot Price – Strike Price)||Time Value for ITM (T=P-I) & OTM (T=P)|
The final premium consists of intrinsic value at expiry and the total time value becomes zero. For E.g. Suppose in the current month Nifty expires in 9934.8 then 9900CE premium will be approximately equal to 34.8 and its total time value of 96.25 will become zero.
So, assume someone sells/short 9900CE today at that point they will receive a premium of 131.05 and also will be safe till nifty expires at any value below 10031.05 (9900+131.05). They will face loss only above 10031.05, the amount by which nifty expires above this price. For E.g. If nifty expires in 10055 then there will be loss of (10055-10031.05=23.95).
And suppose if someone sells/short 10100CE today they will receive a premium of 38.6 and will be safe till nifty expires at any value below 10138.6 (10100+38.6). They will face any kind of loss only above this amount.
List of Options Trading Strategies
Trading unhedged options can give good profit if our view goes completely right, however, if our view goes wrong it may result in huge loss. In stock market anticipating the right direction and the magnitude of movement is highly difficult. So, it is important to develop a trading mechanism that can give some profit even if our view is partially correct or partially wrong and a small amount of loss if our view is completely wrong. And this is possible by using options trading strategies.
They are the combination of call, put and future options. There are ‘n’ number of strategies available, here I have covered some simple but powerful Option Trading Strategies which are used regularly. And with reference to these, we can customize our own option strategies.
|1||Bull Call Spread||Bullish||Limited Risk-Limited Reward|
|2||Bear Call Spread||Bearish||Limited Risk-Limited Reward|
|3||Bull Put Spread||Bullish||Limited Risk-Limited Reward|
|4||Bear Put Spread||Bearish||Limited Risk-Limited Reward|
|5||Long Straddle||Bullish-Bearish||Limited Risk-Unlimited Reward|
|6||Long Strangle||Bullish-Bearish||Limited Risk-Unlimited Reward|
|7||Short Straddle||Neutral||Unlimited Risk-Limited Reward|
|8||Short Strangle||Neutral||Unlimited Risk-Limited Reward|
|9||Call Backspread||Bullish||Limited Risk-Limited Reward|
|10||Put Backspread||Bearish||Limited Risk-Limited Reward|
|11||Covered Call||Bullish||Unlimited Risk-Limited Reward|
|12||Covered Put||Bearish||Unlimited Risk-Limited Reward|
|13||Protective Call||Bearish||Limited Risk-Unlimited Reward|
|14||Protective Put||Bullish||Limited Risk-Unlimited Reward|
|15||Collar||Bullish||Limited Risk-Limited Reward|
|16||Iron Condor||Neutral||Limited Risk-Limited Reward|
|17||Calendar Spread||Neutral||Limited Risk-Limited Reward|
|18||Butterfly Spread||Neutral||Limited Risk-Limited Reward|
|19||Long Call Lader||Bullish||Unlimited Risk-Limited Reward|
|20||Long Put Lader||Bearish||Unlimited Risk-Limited Reward|
|21||Call Ratio Spread||Bullish||Unlimited Risk-Limited Reward|
|22||Put Ratio Spread||Bearish||Unlimited Risk-Limited Reward|
Some Option Trading Strategies Explained
Bull Call Spread Options Trading Strategy
This is a limited risk limited reward options trading strategy used for bullish view. This means if our view goes wrong there will be a limited loss.
Strategy: Buy 1 lot of In the money [ITM] or just out of the money [OTM] call option and sell 1 lot of 2 strikes higher out of the money call option.
For Example, if Nifty spot is trading at 10637 then
Buy 1 lot of 10600CE @128
Sell 1 lot of 10800CE @45
In this strategy maximum profit will be 8805/- and maximum loss will be -6195/-. Max loss amount can be further reduced by adjustment. Instead of selling 2 strike higher call option one can sell 1 strike higher call option, this will reduce profit potential but reduce risk amount as well. So, depending upon how strong our view is we can select strike price and adjust the risk-reward amount.
Check below payoff chart for profit loss analysis at various strikes and find breakeven points.
In this options trading strategy Breakeven point is 10682, this means if Nifty expires above this level our position will be in some profit and if Nifty expires below this level, we will face some loss. Also, here max loss is at 10600 level, if Nifty falls below this level our loss will be limited to 6195/-. Similarly, max profit will be at the strike of 10800. Even if any further upside happens our profit amount will remain the same as 8805/-. So, this explains limited risk and limited reward strategy.
Greek analysis has been explained in the Advance Options Trading course.
- In this strategy, the time decay amount is very small so we can hold this position for several days.
- Also, delta, gamma & Vega values are well controlled in such a way that in case of upside or rise in volatility profit will keep on increasing and in case of fall or drop in volatility there will be a small loss.
- Very good Risk Reward ratio of greater than 1.
- Directional strategy for bullish view.
Bear Call Spread Options Trading Strategy
This is a limited risk limited reward options trading strategy to be used for a bearish view. This means if our view goes wrong there will be a limited loss.
Strategy: Sell 1 lot of out of the money [OTM] call option and Buy 1 lot of 1 strike higher out of the money call option.
For Example, if Nifty spot is trading at 10770.65 then
Sell 10800CE @ 59
Bull 10900CE @ 29
In this strategy maximum profit will be 2250/- and maximum loss will be -5250/-. Check below payoff chart for profit loss analysis at various strikes and find breakeven points.
In this options trading strategy Breakeven point is 10830, which means if Nifty expires above this level our position will be in some loss and if Nifty expires below this level, we will get some profit. And here max loss is at 10900 level, if Nifty rises above this level our loss will be limited to 5250/- only. Similarly, max profit will be at the strike of 10800. Even if any further fall happens our profit amount will remain the same as 2250/-. So, this is a limited risk and limited reward options trading strategy.
An important takeaway from this options trading strategy is the safe range, we are entering into the trade at 10770 level for bearish view. However, our loss will start above 10830, which means even if our view goes wrong by 60 points still, our trade will not be in loss, rather it will give some profit.
- In this options trading strategy, Time decay is in our favor, so the sideways movement of Nifty will keep adding profit in this trade. So, it is good to hold this position for several days.
- No Loss even if Nifty expires 60 points above the entry price
- Risk Reward is not attractive.
- Suitable option strategy for the range-bound market.
Options Trading is a very vast topic but it has huge earning potential if used properly. One needs to understand its basics thoroughly which are useful in creating advance level strategies. Options trading can be harmful if used without proper knowledge. So, beware gain proper knowledge and make the best use of it.
Other Options Trading Strategies are explained in the Advanced Options Trading Course.