You’re excited to begin trading, but it’s important to get a solid foundation in how options work. Many strategies can help you achieve your goals and make plenty of profit along the way. These are a list of some of the various strategies you can use to begin trading options.
Covered Call Writing
A covered call, or “buy-write,” is a call where an investor sells a stock he already owns. It limits the potential of the assets, but it provides the investor with immediate income that was already generated. Sometimes, covered call is used to protect an investor against a potential loss, or when they have a short-term neutral view of an asset.This strategy is not employed by someone with a bullish investment style, but it does serve as a short-term small edge option on a long stock position. By participating in a covered call, an investor is forfeiting the potential of a stock’s increase and is obligated to provide the number of shares offered to the buyer of the option if exercised.
Cash-Secured Put
A cash-secured put is perfect for an investor that would like to acquire shares in a particular security but is willing to wait for them to trade at a target price that is below current market level. Employing a cash-secured put writes a put contract while depositing in the investor’s brokerage account the full cash amount for a possible purchase of underlying shares. The main disadvantage of this strategy is that if the stock declines significantly below the strike price by expiration, the investor may be obligated to purchase shares well above their current price level.
Collar
Collar refers to the protective options strategy that investors use after a stock has experienced substantial gains. Unlike covered call writing, collar is mainly utilized by those who use bullish investing methods—although, even bullish investors remain cautious because they believe that the stock will rise further, but aren’t sure and hedge against the potential drop in value. For example, an investor can purchase 50 shares at $50 each, but also buy a protective put with a strike price of $47 and sell a covered call of $55. Both of these options tradings have the same expiration date and can either earn $5 per share or lose $3 per share. It’s a low-cost way to protect gains and hedge against downside risk.
Credit Spread
A credit spread refers to the purchase of one option and sale of another option in the same class and expiration but different strike positions. It’s called a credit spread because the investor collects cash for the trade. The high priced option is sold, and the less expensive option is bought. This strategy has a market bias because of the limited profits and losses. Bullish strategies traders will use this option when the underlying stock price is expected to move upwards, and bearish strategies investors use credit spread when they expect the underlying stock price to decrease.
