Stock options can be worthwhile derivatives for investors, however, trading them without weighing their pros and cons can be a mistake. Upon buying an option, one gets the right to buy or sell an asset at a certain price and within a set time frame. Options can strengthen an investor’s portfolio when traded using strategies that minimize the risk and maximize the returns. So, here are a few strategies one must consider while trading options:
1. Covered call
One of the most popular option trading strategies is buying a naked call option. The covered call strategy reduces investment risk and helps generate some income. To pull off this strategy, one must purchase the underlying stock as they normally would while simultaneously writing (or selling) call options on the same shares. A call option gives one the right to buy a stock, and a put option gives them the right to sell a stock. For instance, if one uses a call option on a given stock that represents exactly 100 shares of stock for every call option, for every 100 shares of stock one would buy, they will sell a call option against the purchase. So, if the stock price increases rapidly, one’s short call is covered by the long stock position.
2. Protective put
Also known as “married put,” this investment strategy involves hedging the downside risk of 100 shares of long stock in a more definitive way than a covered call. The strategy involves two steps—buying a number of shares of an asset (for example, stock) and simultaneously buying put options for an equivalent number of shares. As one put represents 100 shares, increments are also based on the same 1:100 ratio. This strategy protects investors in case the share price drops.
3. Straddle strategy
This options trading strategy is suitable for investors with a neutral directional assumption, i.e., they are unsure which way the price will move. The strategy comes with two simultaneous positions—an at-the-money (ATM) call and an ATM put. Both positions would be either long or short, and the underlying strike price and the expiration dates are the same for both positions.
Each strategy comes with its own pros and cons and may not work for every investor. So, it is important to do some research and seek expert advice before choosing an options strategy.
