Options Trading is a type of futures contract in which the two traders sign a contract to buy and sell a commodity in the near future. A contract is written by the seller/trader conveying the other trader/buyer about the rights, but it is not an obligation to buy and sell the commodity at a certain price value. Instead, the buyer, in return, grants the seller an amount for the contract.
Options are traded on public exchanges and provide a settlement to the traders by reducing the trading risk. These are used for hedging, knowing future trends, and making strategies to succeed in the trading market.
Types of Options Trading
Options trading is widely used to forecast the market and therefore has two kinds of options. These options are discussed below to have a clear understanding of the options trading.
Call Options: It is an option where the buyer gets the right and not an obligation to buy an asset at a specified price as per the options contract. The trader can purchase the calls when the price of the asset increases and sell when it decreases.
Put Options: In this option, the reversal of call options takes place. The trader gets the right to sell the asset at a price with no obligation as per the contract. Investors buy when the price increases and sell when the price decreases of the asset.
Options have several parts of it that traders use as per their needs and requirements of the trade. But, of course, it also depends upon the instrument or assets a trade invests in. These include:
Premium: It is the price that the buyer pays to the seller as an option.
Expiry Date: It is the date mentioned on the contract of option signed between the buyer and seller.
Strike Price: Also known as exercise price, it is the price at which the contract is signed.
American Option: It is the option employed until the expiry date and can be executed on any date between that.
European Option: It is the option that is performed only on the date of expiry.
Profitable Options Strategies
A trader has several options strategies to trade and earn profits. These strategies help minimise the risk and losses, in all an effective way to trade in the market. However, traders should never blindly use options trading without proper knowledge and understanding. As they are helpful to know the trend, their use without proper study could lead to loss.
The strategies are simple and easy to apply if understood clearly.
A well-known strategy of options trading, Covered call helps in generating income and reducing the risks. It buys the naked call options, a call that is sold itself without any offsetting price. Through this, the sellers are benefited and have limited profits to offer. There are other options to buy-write and cover calls. The seller in this must sell the shares/asset at a short strike price. After purchasing the asset, the trader would sell the same shares.
The strategy is used when the trader has a short term position and no direction on the call. Then, the trader tries to invest and earn through the buying and selling of the premium call. In a call situation, a short call is balanced by the long position of the investment.
In a married put option, the trader purchases the asset/shares and gets the right to sell them at higher prices or the strike price in the trading market. The contracts signed by traders are usually worth 100 each. Through this, the trader protects themselves from future risks. Working similar to an insurance policy, the strategy reduces the downside risk of the shares purchased. Although, it has a drawback of incurring losses when the value of stock held does not decrease. The premium call paid by the investor is not received due to this situation.
Bull Call Spread:
This bullish strategy is used when the investor expects a rise in the price of the asset. In this strategy, the trader buys and sells calls simultaneously; the purchasing price is at the strike rate and selling at a higher rate. A vertical spread strategy limits the upside of the trade and reduces the premium spent. For executing this strategy, the trader must observe the trends.
Bear Put Spread:
It is the opposite of the bull call spread, a vertical spread where the investor buys the puts at the strike price and sells at the high strike price. The trade occurs for the same asset with the same expiry date. It takes place when a trader has bearish sentiments for the asset and expects a decline in the value. There are both limited losses and limited gains available within this strategy of options trading. It though has a condition of fall in the asset’s price, which could be a risk factor.
The strategy deals in both put and call options, where the purchase is made with out-of-the-money put and sells an out-of-the-money call with the same expiry date. Traders use the strategy when their share/asset long position comes to an end with profits. The traders are downside protected as put helps to lock the sale price of the asset/share. But they have an obligation to sell the shares/asset at higher prices giving up on the profits in the near future.
In this strategy, the assets/shares are sold at the money put and purchased at the money put. Simultaneously, they would also sell out of the money call and purchase out of the money call. They have the same expiry date and same assets/shares. It is somehow similar to the butterfly spread. The strategy has both buying and selling of the shares/assets at a time. It could be executed with two spreads combining selling straddles and buying wings.
The long calls and put protect the investor against the downside, and the trader has limited profits using this strategy, but the losses are also limited. Therefore, it is mainly used for gaining small profits.
Options trading is a secure way to conduct a trader with several options for the investor. A trader gets covered call, iron butterfly, protective collar and married put strategies to enhance the trading and profits of the options trading. A profitable strategy for investors if executed well and the trader knows about the options trading.
Traders must use the analysis and tools for having great opportunities to trade in the market. The market is quite uncertain, and the use of these trading strategies could increase the knowledge and profits of the investor. The best way a trader could trade is with the help of these charts, patterns and tools.