Unlike when you are trading stock options by their very nature create different opportunities for defining risk and reward. There are a number of stock options trading strategies that one can employ to take advantage in a price move of a stock while limiting and defining your downside. These hedging strategies are common, in this article we will go over some of the basics.
If you are the owner of a stock but would like to derive some income off of it without having to deal with capital gains on the sale of the entire position you can write a covered call and sell it. Since 90% of all options contracts expire worthless this is a good strategy for making a small amount of money for a stock that you were not going to sell anyway. You sell a call for your shares and immediately pocket the premium. That money is yours whether the contract is exercised or expires. If the stock is not exercised before expiration then the contract expires and you keep both the premium and your shares. At this point you may write another call and repeat the process. The risk is that the price rises to meet the price in the call contract and the buyer of the contract exercises his right to buy. At which point you sell the shares to the holder of the call. You are paid for your shares the price stipulated in the contract.
The most basic stock options trading is the buying of a call or a put. Simply, you buy a call if you think the price of the stock will increase before the expiration. If it does you make money. Conversely, if you buy a put you are betting that the stock will drop in price and when it does you make money. These are un-hedged bets similar to that of playing a hand of poker and carry with them the potential for 100% loss of capital.
Another stock options trading strategy is the ‘bull call spread.’ This entails buying a call at or near the current price as well as a put above the call price and the current price. By doing this you are foregoing profits for small movements up in price for the peace of mind of having protection against price collapse. As the call increases in price the put decreases. Profit happens after the call is worth more than you paid for the put.
Conversely, you could construct a similar spread if you are bearish by buying a put spread by buying an out-of-the-money call and an at-the-money put. This stock options trading strategy has the exact same potential for gain as the bull call spread but with profit occurring at a price lower than the current price as opposed to higher.Previous Post » Stock Options: Understanding How They Work