Option trading strategies
- Covered Call
Market opinion: Neutral to bullish on the underlying asset
A covered call is a popular options strategy that offers limited return with limited risk. To execute a covered call strategy, an investor who holds a long position in an asset can sell call options on that same asset to generate an income stream. A covered call is a kind of hedged strategy, in which it is often employed by the investors who intend to hold the underlying asset for a long time but don’t expect an appreciable price increase in the near term. So the investor holds the asset long and simultaneously has a short position via the option to generate income from the option premium.
- Married Put
Market opinion: The investors are bullish overall, but worry about a sharp temporary decline in the underlying asset price.
In a married put strategy, an investor buys an asset (such as stock) and simultaneously purchases put options for an equivalent number of shares. By owning the put as well as the stock, the investor is protected from any downside below the put's strike price, since the investor can exercise the put and sell the underlying. Simply put, buying a protective put is similar to buying insurance against a stock's decline.
For example, let's say that a stock is trading at $100 and you purchase the underlying shares at $100. If you wanted to protect against the possibility of the stock falling below $90, you could purchase a $90 put.
- Bull call spread
Market opinion: Looking for a steady or rising stock price during the life of the options.
Establishing a bull call spread involves the purchase of a call option on a particular underlying stock, while simultaneously writing a call option on the same underlying stock with the same expiration month, at a higher strike price. Profit is limited if the stock price rises above the strike price of the short call, and potential loss is limited if the stock price falls below the strike price of the long call (lower strike). Usually, traders use the bull call spread if they believe an asset will moderately rise in value.
- Bear call spread
Market opinion: Looking for a decline in the underlying stock’s price during the life of the options.
A bear call spread consists of one short call with a lower strike price and one long call with a higher strike price. The strategy looks to take advantage of a decline in price from the underlying asset before expiration. Potential profit is limited to the net premium received less commissions and potential loss is limited if the stock price rises above the strike price of the long call.
- Long Straddle
Market opinion: Looking for a sharp move in the stock price, in either direction, during the life of the options.
A long straddle is an options trading strategy that consists of a long call and a long put with the same underlying stock, expiration date, and strike price. The purpose of a long straddle is to profit either from the underlying stock rising above the upper break-even point or falling below the lower break-even point. The long straddle option strategy is a bet that the underlying asset will move significantly in price, either higher or lower. The risk of a long straddle strategy is that the market may not react strongly enough to the event or the news it generates.
- Long Strangle
Market opinion: The investor is looking for a sharp move in the underlying stock, either up or down, during the life of the options.
A long strangle consists of one long call with a higher strike price and one long put with a lower strike. Both options have the same underlying stock and the same expiration date, but they have different strike prices. The maximum gain of a long strangle strategy is unlimited on the upside, because the stock price can rise indefinitely. On the downside, potential loss could be substantial, because the stock price can fall to zero. The maximum loss is limited, and the loss occurs if the underlying stock remains between the strike prices until expiration.