OPTION STRATEGY

An options contract is a conditional derivative contract that allows a buyer to either sell or buy a security at a specified time in the future. The seller charges option buyers a certain premium for the right to purchase an option contract. If the market prices are unfavorable, the contract expires worthless. There are two types of option contracts: call options and put options. The former option gives the buyer of a call option the right to buy or call the underlying security at a specified future time at a predetermined price. Alternatively, a put option gives the buyer the right to sell an asset at a specified future date at a predetermined price.

What is option strategy?

There are many types of options strategies to maximize profit when using futures and options contracts for own trades. In general, these can be divided into the purchase of call options or put options with a certain frequency. The options strategies are described below as follows:

1. Long Call

A long call occurs when options traders buy call options in a way that leverages their trades by taking advantage of rising prices. Traders using long calls are bullish or bullish on a particular stock, index, or exchange-traded fund. Since they are sure that the price will rise at some point in the future, they take a call option on it at a pre-determined price so that if the price goes up, they are still obliged to call it at the lower one they pre-determined price to buy . This allows them to sell that security at a much higher price, using their call option to their advantage. Therefore, a long call allows traders to maximize profits by being bullish on a particular stock and mitigating the risk associated with buying it outright.

2. Long Put

On the other hand, a long put strategy is a short selling options strategy. Long puts are ideal for traders who have bearish sentiment on a particular stock, exchange-traded fund, or index. Over here traders are waiting for prices to fall so they can leverage their put options. By setting the put option early to a predetermined high price when the price was higher, the trader can take advantage of falling prices by shorting their contracts once the security's market value falls. Now the security can trade at a lower price than the options contract, but you are obligated to sell your security when the contract expires, thereby earning a return.

3. Covered Call

The third type of option strategy is the covered call, which is the preferred strategy for those who accept less risk and are willing to limit their potential to walk away with higher profits in exchange for the greatest possible protection should the stock perform unexpectedly . One can expect a slight or minimal change in the price of the security when adopting the covered call strategy. It involves buying around 100 shares of the underlying asset, followed by selling a call option against all of those shares. Selling the call collects the premium, which lowers your cost basis on the stocks you buy while giving the trader a cushion against an underperforming stock.

Risk vs Reward with Options Trading

Every options strategy carries risks and rewards. The main risk to any of these strategies is that the stock price moves in the opposite direction than expected or not at all. Because of this, some traders prefer a strategy with downside protection options like the covered call to protect their basis. The rewards of some strategies such as long call and long put are higher than the potential rewards of using a covered call option strategy. Therefore, based on one's personal investment goals and risk appetite, one can choose the option strategies that best suit them.

Conclusion

There are loads of other options strategies like the protective put, the married put, the long straddle, and more. However, they all utilize the core principles of having the right to buy or sell a security at any time in the future and take advantage of that opportunity.