An option is a contract that permits an investor to buy or sell an underlying instrument, such as a stock or even an index, at a predetermined price over a certain period of time for a premium paid by the buyer to the seller.
Option Trading
Options are also derivative contracts whose value is derived from an underlying security. Depending on the type of option they have, buyers may buy or sell the underlying asset. With an options contract, the holder is not required to buy or sell the asset if they choose not to. There are two categories of options: call options and put options.
Participants in Options
- Option Buyer: The person who, by paying a premium, acquires the right to exercise his option on the seller/writer.
- Writer/seller of an Option: The party who pays the option premium and is obligated to sell or purchase the asset in the event that the option buyer exercises the option.
- Call Option: An option that gives the holder the right, but not the duty, to purchase a specific asset before a specific date for a predetermined price.
- Put Option: An option that grants the holder the right, but not the obligation, to sell a specified asset for a specified price before a certain date.
The Utility of Exchange Traded Options
Exchange-traded options are a significant class of options that have standardized contract terms and trade on open markets, thereby assisting investors. These products offer a settlement that is insured by the clearing firm, lowering counterparty risk. Options can be used to hedge, predict market direction, engage in arbitrage, or implement trading methods that could result in profits for traders.
- What are Index Options
These are the options with an index as the underlying. In India, the regulators authorized the European style of settlement.
- What are Stock Options
These are options on individual stocks (with the stock as the underlying). The agreement grants the holder the right to buy or sell the underlying shares at the agreed-upon price. Additionally, the regulator has also authorised the American style of settlement for such options.
When done correctly, trading options is one of the most effective ways to build long-term wealth. A list of some of the top option trading strategies is provided below.
Bullish Option Trading Strategies
A few trading strategies for bullish options are listed below, these strategies have historically benefitted investors, however, past performance does not guarantee future returns.
- Bull Call Spread
A Bull Call Spread is a strategy for trading options that fall under the category of Debt Spreads. When traders are positive about a company or ETF but don’t want to take the risk of acquiring shares outright, they can think about buying a call option as a lower-risk bullish strategy. However, even call options can be expensive and may expose investors to greater risk than usual.
In order to lower the initial cost and risk, investors could purchase a bull call spread. In the Bull Call Spread option, investors can still buy a long call option to express their bullish views but can offset some of that cost by selling a short call option to counter it, reducing the risk.
A Bull Call Spread is made by simultaneously purchasing one call option and selling another with a lower cost and a higher strike price, both with the same expiration date.
- Bull Put Spread
The Bull Put Spread Options Trading Strategy is employed by options traders who anticipate a short-term, moderate increase in the price of the underlying asset. This option typically falls under the credit spreads category. Although it is not the most complex option trading strategy, the buying and selling of puts and calls are more complicated.
Therefore, to put it simply, this spread comprises selling a put option and buying a put option with a lower strike. Given that the Short-Put Option will start losing value before the Long-Put Option position, theta decay will work to the advantage in this scenario. Due to theta decay, it would be preferable to execute a bull put position in this situation, as such a position gains value rapidly each day.
- Bull Call Ratio Backspread
Generally, to place this trade, a trader must have a strong positive bias toward the stock. Being moderately bullish might not work for this investment. One of the peculiar things about this approach is that the biggest loss in a Bull Call Ratio Backspread occurs in the direction the trader anticipates the transaction will move. As an alternative to purchasing call options, the Bull Call Ratio Backspread is a bullish technique that may be used. Two steps make up the Call Ratio Backspread: selling one or more at-the-money or out-of-the-money calls and buying two or three calls that are longer in the money than the call that was sold.
- Synthetic Call
A synthetic call, also known as a synthetic long call, is initiated when an investor buys and holds shares. The investor additionally purchases an at-the-money put option on the same stock to hedge against a decrease in the stock’s price. Numerous investors believe that this method might be equated to an insurance policy against the stock falling dramatically while they continue to hold the shares.
Strategies for Trading Bearish Options
A few trading strategies for bearish options are listed below, these strategies have historically benefitted investors, however, past performance does not guarantee future returns.
- Bear Call Spread
When a person’s outlook on the market is largely bearish, he or she may employ a double options trading method known as a “Bear Call Spread.” Using this strategy, a trader will sell a shorter-term call option while simultaneously purchasing a longer-term call option with the same underlying asset and expiration date but a higher strike price. One realises a net profit when the option premium on the call sold is higher than the price of the call purchased.
- Bear Put Spread
When a trader or investor predicts that the price of a security or asset will slightly drop, they will use a bear put spread. A Bear Put Spread is created by buying Put Options and selling an equal number of Puts on the same asset with the same expiration date and a low target price. The difference between these two strike prices minus the total cost of the options is what determines how much money a trader may potentially make utilising this strategy.
- Strip
The Strip Strategy must be used by an investor who is both bullish on volatility and bearish on the market’s direction. This approach involves buying two lots of “At-the-Money Put Options” and “At-the-Money Call Options.” For both options, the same underlying security and expiration month are necessary. The common long straddle is similar to a bearish version of the Strip. With the Strip Strategy, substantial gains are attainable when the underlying makes a significant move in the direction of loss at expiration.
- Synthetic Put
An investor who sells stock short and buys a call is employing a strategy that is risk-equivalent to buying a put option. This options strategy resembles a long put option by holding both a short stock position and a long call option on the same stock. It’s a strategy that investors can adopt if they have a bearish bet on stock but are concerned about the stock’s potential for near-term strength.
Neutral Option Trading Strategies
A few trading strategies are listed below, these strategies have historically benefitted investors, however, past performance does not guarantee future returns.:
- Long Straddles and Short Straddles
One of the top option trading strategies for the Indian market is the straddle. A Long Straddle is one of the simplest market-neutral trading strategies to implement. Generally, profit and loss are unaffected by the market’s direction of movement after it has been applied. The market’s movement can go either way, but that which never changes is its direction. A profit and a loss are generated regardless of the trend as long as it is moving. A trader buys a long call and a long put in a long straddle options strategy. The Short Straddle Options Strategy involves buying a short call and a short put with the same underlying asset, expiration date, and strike price. This technique appears to be the exact opposite of the long straddle strategy because it is used when the market is least volatile.
- Short Strangles and Long Strangles
The Long Strangle, sometimes referred to as the Buy Strangle or Option Strangle, is a neutral trading technique in which slightly OTM Put Options and slightly OTM Call Options with the same underlying asset and expiration date are simultaneously purchased. This long strangles strategy may be used when the trader expects high volatility in the underlying stock in the near future. It is a low-risk strategy with significant profit potential. The maximum loss occurs when the underlying moves noticeably higher or lower at expiration, while the highest gain occurs when the underlying moves noticeably higher or lower. The Short Strangle is an alternative to the Short Straddle. It seeks to improve the trade’s profitability for the option seller. To accomplish this, the breakeven points are widened. This requires substantially more change in the underlying stock or index. In exchange, the Call and Put option may be worthwhile to use. This strategy involves simultaneously selling two options.
Intraday Option Trading Strategies
Here are a few intraday option trading strategies, these strategies have historically benefitted investors, however, past performance does not guarantee future returns.:
- Momentum Strategy
As the name implies, the core idea behind this intraday option trading strategy is to capitalise on market momentum. This involves monitoring the appropriate stocks before a substantial change in market trend. Traders buy or sell securities based on this change. The selection of a stock is influenced by recent events, takeover announcements, quarterly profits, and other factors. Therefore, intraday traders should research such news on the stocks that are on their watchlist and then place buy or sell orders as necessary.
Since share prices fluctuate as a result of numerous outside factors, intraday traders must act quickly to maximise profits. The period for which individuals hold shares is contingent on the market’s momentum.
- Breakout Strategy
Timing is probably one of the most important considerations when it comes to buying and selling securities on the same day. This intraday trading approach entails locating stocks that have broken out of their normal trading range. A trader can also detect stocks that are about to trade in a new price range. In other words, traders must identify the thresholds at which share prices rise or fall. If the price of a stock rises over a certain threshold, intraday traders will consider opening long positions and purchasing shares.
Nevertheless, when stock prices fall below the threshold, it is a sign that traders should think about going short or selling stock.
- Reversal Strategy
This trading approach has a high level of risk. It entails making investing decisions against the market trend, based on analysis as well as calculations. This intraday trading strategy is more challenging than other approaches. This is because intraday traders need to have a considerable understanding of the market. Furthermore, it can be difficult to precisely identify the pullbacks and strengths.
- Scalping Strategy
The scalping trading approach involves profiting from small price changes. This strategy is often employed by intraday traders when buying and selling commodities. In addition, individuals involved in high-frequency trading normally utilize this strategy. Individuals must keep in mind that the entire fundamental or technical setup in its entirety does not have much relevance in this case. However, while using a scalping method, price action is more significant. People who desire to use this intraday trading approach must make sure that the stocks they choose are both volatile and liquid. Furthermore, they must be sure to put in a stop loss for all orders.
- Moving Average Crossover Strategy
The moving average crossover strategy is another effective intraday trading method in India. A shift in momentum can be detected when the prices of stocks or any other financial instrument move above or below the moving average. An uptrend is when share prices increase by more than the moving average. In contrast, a downtrend is considered to exist when stock prices are lower than the moving average.
- Gap and Go Strategy
Finding stocks with no pre-market volume is part of the gap-and-go strategy. The opening price of these stocks represents a gap from yesterday’s closing price. A gap-up occurs when the opening price of a stock is greater than its closing price from the previous day. In contrast, when the opposite occurs, it is known as a gap down. When using this method, intraday traders find these stocks and purchase them with the expectation that the gap will narrow before the closing bell.
Conclusion
In summary, traders can use a number of fundamental tactics that have little risk as opposed to the high risk normally associated with options. Therefore, even traders who are reluctant to take risks can use options to boost their overall results. But before making an investment, it’s important to understand the risks involved so that one can assess whether the possible reward outweighs them.
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