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Options trading allows traders to speculate on price movements, reduce existing positions or generate income in bullish and bearish markets, which is an excellent and changing method for investing in financial markets. Compared with traditional stock trading, options give the right, but not the obligation, to purchase or sell an asset at a fixed price by a specified date. Risk and reward are optimized through various strategies, considering risk tolerances and market outlooks. In this article, we aim to introduce you to some of the most successful, time-tested options trading strategies you can apply to your trading and make a profit accordingly.
What Is a Trading Strategy?
A trading strategy shall consist of a well-defined roadmap or set of rules to be followed by the trader to make decisions concerning buying, selling and holding financial assets on finance markets. It sets out the specific points of entry and exit, as well as risk management and position sizing criteria. The main objective of the trading strategy is to ensure that traders take a structured and disciplined approach to business, enabling them to overcome emotional biases and make sound decisions based on market analysis and established rules.
Various factors may be used to develop trading strategies, including technical analysis, fundamental analysis, or a combination. Technical strategies use historical data and patterns to predict future price movements, while fundamental strategies focus on analyzing an asset’s intrinsic value and financial health.
Depending on their risk tolerance, investment objectives, time horizon and the kind of assets they engage in, different traders can have a variety of trading strategies. Some general trading strategies are trend-following, trend-reversal, rebound, or arbitrage strategies. Various strategies have advantages and limitations, so traders must thoroughly back-test and validate their chosen strategies before implementing them in actual trading situations. Traders seek to raise the odds of success and achieve consistent market profitability by adhering to well-thought-out trading strategies.
Easy Options Trading Strategies
There are diverse trading strategies you can use in Options Trading. Each of them could have their merits and demerits. You must choose the best strategy for your trading goals as a trader. In the following, we have listed the popular options trading strategy and explained their benefits:
Bull Spread Options Trading Strategy
A bull spread is an option investment strategy to take advantage of relatively strong price movements for the underlying asset. It involves purchasing and selling two options of the same type, both calls and puts, but with different strike prices and the same expiry date. The strategy may be applied using both call options and put options to reduce the possibility of profit or loss as much as possible.
There are two main types of Bull Spreads:
Bull Call Spread:
- You can buy a low-strike price call option.
- Sell an option to buy a higher strike price call in parallel.
- Both options should have the same expiration date.
The objective of the Bull Call Spread is to benefit from the underlying asset’s price increase while reducing the cost of entering the trade. A premium income is generated by selling a call option, partly offsetting the costs of purchasing one of the more expensive options. Because of the limited profit potential of the higher strike call option, the maximum profit potential is limited to the initial net debit paid to enter the trade. In contrast, the maximum loss is limited to the initial net debit paid to enter the trade.
Bull Put Spread:
- Sell the put option with a higher strike price.
- At the same time, you can buy put options with a lower strike price.
- The expiry date for each of these options should be the same.
When a trader expects the price of an underlying asset to rise or remain relatively stable, it will be possible to use Bull Put Spreads. Minimizing potential losses involves selling a put option with a higher strike price to raise premium revenue while simultaneously purchasing a put option with a lower strike price. The maximum profits shall be limited to the net premium received at the commencement of a trade. In contrast, the maximum losses shall be capped concerning the difference between the strike prices for both options minus the capital spent.
The main advantage of Bull Spreads is that they offer a more controlled risk-reward profile compared to outright buying or selling options. It allows traders to profit from a favourable view of an asset while ensuring they do not incur any potential loss if the market turns against them. However, when applying Bull Spread strategies, it is essential to consider factors such as implied volatility, time decay and transaction costs. As with any options strategy, it is necessary to understand and manage risks to succeed.
Bear Spread Options Trading Strategy
A bear spread is a strategy of options traders to profit from any moderate downward movement in an asset’s price. Like the Bull Spread, it involves buying and selling two options of the same type, either calls or puts, with the same expiration date but different strike prices. This strategy aims to limit both the possible profits and those that could be lost.
There are two main types of Bear Spreads in options trading:
Bear Call Spread:
- Open a Sell call option position at a lower strike price.
- Simultaneously, open a buy call option position at a higher strike price.
- Both option positions should have the same expiration date.
If the trader expects a fall in the price of an underlying asset, they shall use Bear Call Spreads. The trader receives a premium from selling the lower strike call option, limiting its potential loss by purchasing the upper strike call option. The maximum profit achievable is restrained, as the profit potential of the higher strike call option is limited. In contrast, the maximum loss is limited to the initial net credit received when entering the trade.
Bear Put Spread:
- Open a Buy put option position at a higher strike price.
- Simultaneously, sell a put option at a lower strike price.
- The expiration date for both options should be the same.
A bear put spread shall be used when the trader foresees that the underlying asset price will decrease or stabilize reasonably. It covers the purchase of put options with a larger strike price to avoid possible losses and, at the same time, sell puts that have a lower strike price to earned income. Maximum profit is limited to the net premiums earned during the initial trading period, while the minimum loss may be fixed at a difference in strike prices of both options minus the fund paid.
Bear spreads offer a more controlled risk-reward profile than outright buying or selling options, which is a crucial advantage. They give traders a chance to make profits from a negative view of an asset while at the same time mitigating potential losses if the market is moving in their direction. Traders should consider factors like implied volatility, time decay and transaction costs in applying the Bear Spread strategy compared to all options strategies. To successfully implement it, a proper understanding and risk management are essential.
Butterfly Spread Options Trading Strategy
The Butterfly Spread strategy combines several options contracts to acquire positions with low risk and little profit potential. In general, it is a neutral strategy by which the trader foresees that the price of the asset in question will continue to be relatively consistent with its particular range. A Butterfly spread strategy may be set up using a call or put option involving three strike prices.
Profit and Loss:
- Maximum Loss: At expiration, the maximum loss on a butterfly spread is reached when the price of an underlying asset closes below or above the highest or lowest strike price. In this case, all options expire worthless, and the trader loses the net premium paid to enter the position.
- Maximum Profit: Where the underlying asset’s price is reached at a minimum strike price before its expiry, achieving an optimum profit is possible. In this case, the trader gains the difference between the middle strike price and the two outer strike prices minus the net premium paid.
- Breakeven Points: There are two breakeven points for the spread of butterflies. A lower strike price, plus the net premium to be charged, is the first breakeven level, and a second breakeven level shall be the highest strike price minus the net premium.
The butterfly spread strategy has a limited profit potential since the at-the-money options’ premium generated by sales helps compensate for the costs of purchasing those options with higher and lower strike prices. In the absence of market volatility, in which there is a possibility that the underlying asset will remain under a fixed price range for an extended period before expiry, this strategy performs best.
When implementing butterfly spreads, traders should consider transaction costs, implied volatility and time decay. Before it can be applied, there is a need to understand the market situation and any potential risks.
Protective Put Options Trading Strategy
An options trading strategy investors use to protect their immediate long positions in an asset, for example, stocks, is the Protective Put Strategy. It provides protection and reduces losses when an asset’s value falls to protect itself from any possible downside risks on its price movements.
Here’s how the Protective Put strategy works:
- Own the underlying Asset: The initial step would be to have already held a basic asset, for example, shares. The investor has a solid position in the product and seeks to preserve its value against possible losses.
- Buy a Put Option: An investor also purchases the put option concerning the equivalent number of shares they own in an asset. A hundred shares are usually represented in each put option. A put option allows an investor to sell underlying assets at a predetermined strike price before the expiry date and not be required to do so.
- Expiration and strike price: The expiry date of a put option shall be the day from which investors can exercise this option and its strike price, where they may sell their underlying asset if they take advantage of that option.
- Asset Price Increases: If the price of the underlying asset increases or remains stable, the investor can let the put option expire worthless. In that case, the insurance premium paid for purchasing the put option is the insurance cost, and the investor retains the total value of his long position in the asset.
- Asset Price Decreases: If the price of the underlying asset declines, the put option becomes valuable. The investor may use the put option to sell an asset at a strike price set by him to help limit total losses from his more extended position. The profits of the put option will compensate for the loss due to declining asset prices.
The Protective Put Strategy is designed to provide long-term protection for the investor’s portfolio by ensuring that, even if the asset prices decrease significantly, they may sell it at the strike price on a put option. Thus, as the investor is not bound by selling any asset unless he exercises his put option, a level of flexibility in investment decisions can be maintained.
However, the costs of purchasing a put option that acts like insurance need to be considered as part of the Protective Put Strategy. That cost, commonly called the premium, is a further expense that must be included in an individual investor’s total investment strategy. Nevertheless, the plan provides a strong sense of security and risk management benefits, particularly when faced with market volatility or economic uncertainty.
There is also another type of trading called “Pure BinaryOptions Trading”. In this type of trading, attractive to many traders, you only have two options: “Call” and “Put”. In this kind of trading, you Call or “Buy” a particular asset when you predict the price will go up in a specific period, and you “Put” or “Sell” when you think the price will go down. You won’t have any other type of orders to reduce your risk, such as the types we mentioned above throughout BinaryOptions Trading. The result stands for an “All or Nothing” in this type of trading.
For example, imagine that you have a $100 balance, and you predict that the price of an asset( e.g. EUR/USD) will go up in a specific time (e.g. 5 minutes). Consider the Payout is 80%, meaning you will receive 80% of your position size if you win. You will determine the money you are willing to involve in a position, for example, $10, set the period (5 mins) and press the call button. After 5 minutes, your position will expire, and you will receive your reward, which is $8 if the price is higher than the price you entered, and if not, you will lose all your money, which is $10.
No matter which trading strategy you choose, you must always test your chosen strategy to measure its reliability. There are Demo platforms designed for traders to familiarise themselves with the trading environment and test their strategy. Some demo accounts are free, while others may require small funds to sign up. One of the best Demo Platforms is offered by CloseOption. This broker provides its users with a real-time simulated demo account for free. The platform is straightforward, especially for novice traders. CloseOption’s platform is the best choice for traders who are willing to experience Pure BinaryOptions Trading. You can sign up for free by clicking Here. CloseOption also has one of the most reliable Options Trading Blogs. You can read articles about different options trading and risk management strategies written by experts to become a pro trader.
Whereas the “Best” strategy is based on one’s preferences, tolerance for risk and market trends, specific strategies, like those mentioned above, are distinguished by their adaptability and potential to deliver consistently high returns.Join Us to Learn How to Succeed in Your Trading person_addRegister