Options strategies
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An option strategy is usually implemented by combining one or more option positions and zero or more underlying positions. The option positions used can be long and/or short positions in calls and/or puts at various strikes.
Generally, options trading strategies can classified to be bullish, bearish or neutral. In the case of neutral strategies, they can be further classified into those that are bullish on volatility and those that are bearish on volatility.
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[edit] Bullish Strategies
Bullish options strategies are employed when the options trader expects the underlying stock price to move upwards. It is necessary to assess how high the stock price can go and the timeframe in which the rally will occur in order to select the optimum trading strategy.
The most bullish of options trading strategies is the simple call buying strategy used by most novice options traders.
In most cases, stocks seldom go up by leaps and bounds. Moderately bullish options trader usually set a target price for the bull run and utilize bull spreads to reduce risk. While maximum profit is capped for these strategies, they usually cost less to employ. The bull call spread and the bull put spread are common examples of moderately bullish strategies.
Mildly bullish trading strategies are options strategies that make money as long as the underlying stock price do not go down on options expiration date. These strategies usually provide a small downside protection as well. Writing out-of-the-money covered calls is a good example of such a strategy.
[edit] Bearish Strategies
Bearish options strategies are employed when the options trader expects the underlying stock price to move downwards. It is necessary to assess how low the stock price can go and the timeframe in which the decline will happen in order to select the optimum trading strategy.
The most bearish of options trading strategies is the simple put buying strategy utilised by most novice options traders.
In most cases, stock price seldom make steep downward moves. Moderately bearish options traders usually set a target price for the expected decline and utilise bear spreads to reduce risk. While maximum profit is capped for these strategies, they usually cost less to employ. The bear call spread and the bear put spread are common examples of moderately bearish strategies.
Mildly bearish trading strategies are options strategies that make money as long as the underlying stock price do not go up on options expiration date. These strategies usually provide a small upside protection as well. A good example of such a strategy is to write of out-of-the-money naked calls.
[edit] Neutral or Non-Directional Strategies
Neutral strategies in options trading are employed when the options trader does not know whether the underlying stock price will rise or fall. Also known as non-directional strategies, they are so named because the potential to profit does not depend on whether the underlying stock price will go upwards or downwards. Rather, the correct neutral strategy to employ depends on the expected volatility of the underlying stock price.
[edit] Bullish on Volatility
Neutral trading strategies that are bullish on volatility profit when the underlying stock price experience big moves upwards or downwards. They include the long straddle, long strangle, short condor and short butterfly.
[edit] Bearish on Volatility
Neutral trading strategies that are bearish on volatility profit when the underlying stock price experience little or no movement. Such strategies include the short straddle, short strangle, ratio spreads, long condor and long butterfly.
[edit] See Also
[edit] References
- McMillan, Lawrence G. (2002). Options as a Strategic Investment, 4th ed., Prentice Hall. ISBN 0-7352-0197-8.
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