Strategies for Trading Options
When you’re trading with options, you should have a good understanding of what you are trading. A simple way to describe options trading is this: if you buy stock in a company, you are investing money in that company because by owning the stock, they are obligated to pay out dividends or give up value in some other way.
When buying an option, you are not directly giving your money to anyone; instead, you are obtaining the right (but not obligation) to execute on someone else’s investment plan. View website for more info.
You are using options with one goal in mind: to make money. This strategy is simply trying to catch the market on a move. The key here is that it must be high volume or very strong momentum for this option play to work.
This next trading strategy is more complicated than simple directional plays but can yield higher returns over time. Using this strategy means anticipating unexpected changes in the underlying stock’s price levels, usually due to an external event such as a court case, election results, or earnings release coming out that will influence the price of the company’s shares. For example, if there is an upcoming court case that has a 50% chance of going either way, and the company’s stock price is £50.00 – you would purchase calls on the exposure to the upside at £5.00 – £7.50 and set your expiry period to be two months away.
Using volatility arbitrage means looking for discrepancies in pricing between options with different strikes or periods. By purchasing an option with higher implied volatility and selling one with lower implied volatility, you can create a position that will benefit if there is a movement in the underlying stock up or down. For example, if ABC company’s shares are trading at £55.00 and its January expiry call options for this month are at £10.00, while the April call options are at £5.00 – you would purchase the January expiry calls for this exposure. You would then sell the April ones that have lower implied volatility to hedge your exposure.
An iron condor is like an insurance policy; you can’t lose money on it if things stay exactly as they are now (although there may be some minor costs), and if things go better than expected-you make significantly more money. The key to success with this strategy is finding two stocks for this play to work. You want one underlying stock showing moderate performance and another with high activity (one of these should typically be in a different sector).
Calendar spreads are the same as above, but instead of holding it until expiry, you want to close out before expiry. So there is no chance of losing all your money, which means buying the closer expiration call and selling the further expiration one at a lower price than what you paid. You can even sell it back for higher than what you paid if the stock moved up significantly. By selling this option earlier than expected, you can lock in gains quickly without waiting until expiry.
A Covered call is like an insurance policy for your stocks. If prices go up, you make money on the stock appreciation; you make money with the option premiums if they go down. The key to this strategy is having shares available to sell if needed. Also, you must research the company whose stock you’re investing in and ensure that it’s not performing poorly (i.e. no pending lawsuits or anything negative in recent news).
This is very similar to covered calls; however, instead of selling someone else an options contract, you are buying one, so there will be no chance of losing all your money if prices drop dramatically. To execute this strategy, select a stock you’re already holding and purchase a put contract with the same strike price as the one currently in use. By doing this, should prices drop beyond your threshold – you’ll be covered by the option you’ve purchased.