Options Trading Strategy

how to start trading

Many people new to options get a little overwhelmed by all the strategies and usually have a hard time trying to find the best options trading strategy.

Honestly, there is no “Best” strategy but there are definitely specific strategies for different types of trading and usually the best suggestion is to start slow with the basic strategies and evolve as you get more experience. Below are the main options trading strategies but realize that there are many more less common ones that aren’t mentioned.

Also, the options strategies you use will vary depending on your risk tolerance, size of account, timeframe (monthly vs. weekly options), and investment goals(income trading, growth trading, hedging portfolio).

Basic Options Trading Strategies

What makes a strategy be considered “Basic” ? Honestly, the basic strategies are more risk controlled usually integrating a stock position or a defined risk.

  • Covered Calls – Selling calls against a long stock position.
  • Cash Secured Puts – Selling naked puts without owning the stock but having the funds set aside to buy the stock outright if put to you.
  • Collar Trades – Buying a put to protect downside risk on a stock position and selling out of the money calls to pay for those protective puts.
  • Debit Credit Spreads – Buying a call and simultaneously selling a call with a higher strike price to help pay for the cost of the call you bought. Your risk is limited to the difference in premium paid vs. premium collected.

Intermediate Options Trading Strategies

Intermediate strategies begin to integrate multi-leg strategies and a better understanding of option pricing and varied risk/reward.

  • Vertical Put Credit Spreads and Call Credit Spreads – Sell a call(or put) and buy a farther out of the money call(or put) to hedge. The sold call(put) which is closer to the money brings in a larger premium than the sold call(or put) so you receive a credit in your account. Credit spreads have higher risk/reward then debit credit spreads so they are being classified as intermediate strategy as you have to have knowledge of technical analysis with credit spreads.
  • Calendar Spreads – Sell a near-term expiration call(or put) and buy a farther out expiration call(or put) with the same strike price.
  • Diagonal Spreads – Sell(or buy) a near-term expiration call(or put) and sell(or buy) a long term expiration call(or put) at a difference strike price. Essentially think of a vertical spread(different strikes) but with different expiration periods.
  • Iron Condor – Combining 2 out of the money vertical credit spreads in the same expiration period so selling a vertical call credit spread and a vertical put credit spread on the same stock.
  • Straddles – Buying a straddle means buying a call and put at the same strike price(usually at the current market price) or selling a straddle (selling at the money call and puts at the same strike price).

Advanced Options Trading Strategies

Advanced strategies involve more risk or understanding on combining multiple strategies. You should have a solid understanding of how to adjust options trades when using advanced strategies.

  • Ratio Spreads – Buying a call and selling¬† 2 farther out of the money calls.
  • Combinations – Buying a call and selling a put at the same strike price.
  • Short Strangle – Selling a put an call (with no controlled risk hedge like Iron Condors have).
  • Double Diagonals – combining 2 diagonal spreads at once. Like an Iron Condor but instead you are using 2 expiration periods so you have additional. Have to have a better understanding of adjusting trades and understanding volatility pricing and skews.

Summary

I was going to go through in more detail each of these trading strategies but I found a great resource (site owned by broker TradeKing) that explains each strategy in good detail with nice risk/reward charts for each strategy (the site shows you other strategies not mentioned in this post but just focus on a couple of the main strategies above or you will get overwhelmed). Here is the site:   http://www.optionsplaybook.com/

Any Questions ? post your comments below:

Next Options Trading Lesson: Options Trading Systems

Learn Options Trading: Main Page

Leave a Reply