Options Trading can generate humungous profits if done with proper knowledge. Most traders simply jump into options trading without acquiring the proper knowledge of its strategies. These strategies can pull you out of losses many times, and today we will be covering “Most Popular Options Trading Strategies” in our PDF. You can bookmark this page or download this PDF for free!
By the way, we also have uploaded the comprehensive Most Profitable Candlestick Patterns PDF, do check it out!
What is Options Trading?
Options are a sort of contract in which the buyer has the right to buy or sell a security at a defined price in the future. An option holder is effectively paying a premium for the right to buy or sell the security within a specified time frame.
If market prices become unfavorable for option holders, they will allow the option to expire worthless and not exercise their right, ensuring that possible losses do not exceed the premium. If the market moves in a favorable direction, the holder may decide to exercise the contract.
Options are often divided into “call” and “put” contracts. A call option grants the buyer of the contract the right to acquire the underlying asset in the future at a fixed price, known as the exercise price or strike price. A put option gives the buyer the right to sell the underlying asset in the future at a fixed price.
Well, this was just an overview of call-and-put contracts, we already have covered even these basic points in our options trading strategies pdf. So, stay along!
Commonly Used Terms in Options Trading
| Term | Explanation |
|---|---|
| Option | A contract giving the right to buy or sell an asset at a set price. |
| Call Option | Gives the holder the right to buy an asset at a specified price. |
| Put Option | Gives the holder the right to sell an asset at a specified price. |
| Strike Price | The set price at which an option can be exercised. |
| Expiration Date | The date on which an option contract becomes void. |
| Premium | The price paid for purchasing an option. |
| In the Money (ITM) | Option with intrinsic value (profitable if exercised now). |
| Out of the Money (OTM) | Option with no intrinsic value (not profitable if exercised now). |
| At the Money (ATM) | Option with strike price close to the current market price. |
| Exercise | Act of using the right to buy or sell the underlying asset. |
| Assignment | Obligation to fulfill the terms of the options contract. |
| Covered Call | Writing call options while owning the underlying asset. |
| Naked Option | Writing options without owning the underlying asset. |
| Implied Volatility | Market’s forecast of a likely movement in the asset’s price. |
| Intrinsic Value | The real value of an option if exercised now (ITM value). |
| Extrinsic Value | The portion of the option’s price not accounted for by intrinsic value. |
| Delta | Measures the change in option price relative to the change in the underlying asset’s price. |
| Gamma | Measures the rate of change of Delta over time or for one unit change in the price of the underlying asset. |
| Theta | Measures the rate of decline in the value of an option due to the passage of time. |
| Vega | Measures the sensitivity of an option’s price to changes in volatility. |
| Rho | Measures the sensitivity of an option’s price to changes in interest rates. |
Most Popular Options Trading Strategies PDF Downloading Link
Options Trading Strategies Explained
Below we have covered some of the important strategies with their explanation and easy-to-comprehend examples.
Covered Call
First in our list of Options Trading Strategies is Covered Call. A covered put is a strategy that is devised when an investor intends to short shares in the underlying and feels that the price of an underlying Stock/ Index is going to remain range-bound or move down. In Covered Put, an investor sells a Put Option on a stock he is short on.
This leads to an inflow of premiums for investors. The profit is capped till the underlying remains below the Strike price. If the underlying crosses the Strike Price, the Put Option will start making loss and there could be chance of unlimited loss. Investors can use this strategy to earn income in a neutral market.
Example: Nifty is currently trading @ 5400. The investor has sold one lot of Nifty Futures @ 5500. A covered Put strategy can be initiated by selling Put Option Strike 5300 @ 50. Investors are not expecting the underlying to cross 5300!
Married Put
In a married put strategy, an investor buys an asset, such as stock, and then buys put options for the same amount of shares.
A put option gives the holder the right to sell stock at the strike price, and each contract is worth 100 shares.
An investor may opt to employ this method to mitigate their downside risk when holding a stock. This method works similarly to an insurance policy, establishing a price floor in the event that the stock’s price falls dramatically. This is why it’s also known as a “protective put.”
Example: Assume a trader decides to buy 100 shares of XYZ stock for ₹20 each and one XYZ ₹17.50 put for ₹0.50 (100 shares x ₹0.50 = ₹50). With this combination, they purchased a stock position for ₹20 per share while simultaneously purchasing insurance to protect themselves if the stock falls below ₹17.50 before the put expires.
Let’s imagine the stock price falls abruptly to ₹15 per share. The trader’s loss of ₹5 per share on the long position may be somewhat mitigated by the ₹2.50 profit from the put.
Bull Call Spread
Now next on our list of Options Trading Strategies is Bull Call Spread. This is a strategy that must be devised when the investor is moderately bullish on the market direction going up in the short term. A Bull Call Spread is formed by buying an “In-the-Money Call Option” (lower strike) and selling an “Out-of-the-Money Call Option” (higher strike). Both the call options must have the same underlying security and expiration month.
The net effect of the strategy is to bring down the cost and break even on a Buy Call (Long Call) strategy. The investor will benefit if the underlying Stock/Index rallies. However, the risk is limited on the downside if the underlying Stock/Index makes a correction.
Example: Nifty is currently trading @ 5500. Investors are expecting the markets to rise from these levels. So buying the Put Option of Nifty having Strike 5400 @ premium 150 and selling the Call Option of Nifty having Strike 5600 @ premium 50 will help investors benefit if Nifty goes above 5500.
Bear Put Spread
Bear Put Spread is an options trading strategy that must be devised when the investor is moderately bearish on the market direction and is expecting the underlying to fall in the short term. A Bear Put Spread is formed by buying an In-the-Money Put Option (higher strike) and selling an Out-of-the-Money Put Option (lower strike). Both Put options must have the same underlying security and expiration month.
The investor has to pay a net premium because the Put bought is of a higher strike price than the Put sold. The net effect of the strategy is to bring down the cost and raise the breakeven on buying a Put (Long Put).
Example: Nifty is currently trading @ 5500. Investors are expecting the markets to fall down drastically from these levels. So selling a Put option of Nifty having strike 5400@ premium 50 and buying a Put option of Nifty having strike 5600 @ premium 150 will help investors benefit if Nifty stays below 5500.
Collar
Collar is a strategy that is devised when an investor is holding shares in the underlying and feels that the underlying position is good for the “medium to long term” but is moderately bullish in the near term. In Collar, an investor sells a Call option on a stock he owns.
The investor also buys a Put Option to insure against the fall in the price of the underlying. This is a low-risk strategy since the Put prevents downside risk. The profits are also capped on the upside because the Call sold prevents profits when the underlying rallies.
Example: Nifty is currently trading @ 5400. The investor has bought one lot of Nifty Futures @ 5400. Collar can be initiated by selling Call Option Strike 5500 @ 70 and buying Put Option Strike 5300 @ 50. The investor benefits if Nifty stays above 5500.
The reward is limited to 6250 [calculated as the (difference in adjacent Sell Call strike price and Underlying
Buy price + premium received) * Lot Size].
The risk is limited to 3750 [calculated as the (difference in adjacent Underlying Buy price and Buy Put strike
price – premium received) * Lot Size].
Long Strangle
Long Strangle is a options trading strategy to be used when the investor is Neutral on the market direction and bullish on volatility. This strategy involves buying an “Out-of-the-Money Call Option” and buying an “Out-of-the-Money Put Option”. Both options must have the same underlying security and expiration month. Long Strangle is a slight modification to the Long Straddle to make it cheaper to execute. The investor makes a profit when the underlying makes significant movement on the upside or downside. The strategy has limited downside.
Example: Nifty is currently trading @ 5500. A Long Strangle can be created by buying Put strike 5400 @ premium of 40 and buying Call strike 5600 @ 60 respectively. The net outflow of premium is 100.
Long Call Condor
Long Call Condor is a strategy that must be devised when the investor is neutral on the market direction and expects volatility to be less in the market. A Long Call Condor strategy is formed by buying the Out-of-the-Money Call Option (lower strike), buying the In-the-Money Call Option (lower strike), selling the Out-of-the-Money Call Option (higher middle), and selling the In-the-Money Call Option (higher middle).
All Call Options must have the same underlying security and expiration month. This strategy is very similar to a Long Call Butterfly. The difference is that the sold options have different strikes. The profit payoff profile is wider than that of the Long Butterfly.
Example: Nifty is currently trading @ 5500. Buying Call Option of Nifty having Strike 5300 @ premium 280,
Strike 5700 @ premium 50 and Selling Call Option Strike 5400 @ premium 200, Strike 5600 @ premium 90 will help the investor benefit if Nifty trades between 5400 and 5600.
Short Call Condor
Short Call Condor is a strategy that must be devised when the investor is neutral on the market direction and expects markets to break out of a trading range, but is not sure in which direction. A Short Call Condor strategy is formed by selling an “Out-of-the-Money” Call Option (lower strike), selling “In-the-Money” Call Option (lower strike), buying “Out-of-the-Money” Call Option (higher middle), and buying “In-the-Money” Call Option (higher middle).
All Call Options must have the same underlying security and expiration month. This strategy is suitable in a volatile market. The maximum profit occurs if the underlying finishes on the either side of the Upper or Lower Strike prices at expiry.
Example: Nifty is currently trading @ 5500. Selling Call Option of Nifty having Strike 5300 @ premium 280,
Strike 5700 @ premium 50 and Buying Call Option Strike 5400 @ premium 200, Strike 5600 @ premium 90 will help investors benefit if Nifty on expiry stays below 5300 or above 5700.
Long Call Butterfly
Long Call Butterfly is a strategy that must be devised when the investor is neutral on the market direction and expects volatility to be less in the market. A Long Call Butterfly strategy is formed by selling two At-the-Money Call Options, buying one Out-of-the-Money Call Option and one In-the-Money Call Option. A Long Call Butterfly is similar to a Short Straddle except that here the investor’s losses are limited. The investor will benefit if the underlying Stock/ Index remains at the middle strike at expiration.
Example: Nifty is currently trading @ 5500. Buying Call Option of Nifty having Strike 5400 @ premium 200,
Strike 5600 @ premium 80 and selling two lots of Call Option of Nifty having Strike 5500 @ premium 130 will help the investor benefit if Nifty expiry happens at 5500.
Short Call Butterfly
Short Call Butterfly is an options trading strategy that must be devised when the investor is neutral on the market direction and expects volatility to be significant in the market. A Short Call Butterfly strategy is formed by buying two “At-the-Money Call” Options, selling one “Out-of-the-Money Call” Option and one “In-the-Money” Call Option. Compared to Straddle and strangle, this strategy offers very small returns. The risk involved is slightly less as compared to them. The investor will benefit if the underlying Stock/ Index finishes on either side of the upper and lower strike prices at expiration.
Example: Nifty is currently trading @ 5500. Selling Call Option of Nifty having Strike 5400 @ premium 200,
Strike 5600 @ premium 80 and Buying 2 lots of Call Option of Nifty having Strike 5500 @ premium 130 will help the investor benefit if Nifty on expiry stays below 5400 or above 5600.
Bottom Line
While options trading can be scary for new market participants, there are several tactics that can help limit risk while increasing profit. Some options trading strategies, such as butterfly and Christmas tree spreads, incorporate many offsetting choices. Covered calls, collars, and married puts are available to people who have already invested in the underlying asset, while straddles and strangles can be utilized to construct a position when the market moves.
FAQs
Q: What options trading strategies are profitable in a sideways market?
A: In a sideways market, where prices don’t change much over time, short straddles, short strangles, and long butterflies are profitable. These strategies benefit from low volatility, as the premiums received from writing the options are maximized if the options expire worthless.
Q: Are protective puts worth the cost?
A: Yes, protective puts are similar to insurance. You pay a premium for the protection, and while you hope you never need to use it, it can save you from significant losses if the market crashes.
Q: What is a calendar spread in options trading?
A: A calendar spread involves buying (or selling) options with one expiration date and simultaneously selling (or buying) options on the same underlying asset with a different expiration date. This strategy is often used to bet on changes in the volatility term structure of the underlying asset.
Q: What is a box spread in options trading?
A: A box spread is an options strategy that creates a synthetic loan by going long a bull call spread and simultaneously going long a matching bear put spread using the same strike prices.
Q: Why do traders use box spreads?
A: Traders use box spreads for money management purposes, to effectively borrow or lend funds based on the implied interest rate of the box spread.