Best Option Trading Strategies that Every Trader Should Know

In case you wish to scale up your stock trading, you can familiarise yourself with option trading strategies. If you are planning to hit the trading floor, this article has you covered and teaches you about some of the best option trading strategies, their implications, and how to use them. A background in basic options trading strategies may be a good idea for you to master some further complex moves described here. 

When you have a handle on trading options, you may find that this is an efficient way to reach your investment goals. An option is a contract that is an agreement to buy or sell an underlying asset at a predetermined price (the strike price) on a certain fixed date (the expiry date). In an options contract, both parties entering the contract/agreement have the right to buy or sell the underlying asset but not the obligation to carry out the contract. In option trading, a buyer of the contract must pay the seller a premium to get into the options contract. 

Best Option Trading Strategies that Every Trader Should Know

Some of the best option trading strategies are discussed here, and whether traders use them or not, they should be aware of what they are. Any option trading strategy may be executed based on the trader’s style and risk profile. Furthermore, knowledge of an options trading strategy is relevant to adapting to volatile markets and making the most of opportunities. 

Bullish Options Trading Strategies 

Bullish options strategies are used in bullish markets, where sentiment is positive and the prices seem on the upward trend. Here are some key bullish options strategies: 

1. Bull Call Spread 

A bull call spread reduces your initial cost as well as your risk. With this strategy, traders can buy a long-call option but can compensate for the cost by selling a short-call option, thus mitigating risk. 

2. Bull Put Spread 

The bull put spread is used if a trader thinks that the price of the underlying options contract asset will rise moderately and soon. In this option trading strategy, the trader will sell a put option and buy a put option with a strike price that is lower. In this event, Theta decay can be beneficial for traders as the short-put loses value quickly, relative to the long-put position. Such a strategy is executed when you wish to buy an option contract. 

3. Bull Call Ratio Backspread 

If you wish to adopt an options trading strategy considered potentially best for option selling, you may attempt the bull call ratio backspread. Using this, the trader must be very bullish concerning the market. Furthermore, this strategy involves selling one or more than one at-the-money or out-of-the-money calls and buying two or three longer in-the-money calls relative to the call that was previously sold. 

4. Synthetic Call 

In stock options trading, this strategy is also called the synthetic long call. Here, a trader buys and holds stock when starting to employ this strategy. If a trader wishes to hedge against a decrease in the price of a stock, the trader also purchases an at-the-money put option for the same stock bought earlier. Considered as an insurance policy, this is a safeguard used against the potential sharp reduction in a stock’s price. 

Bearish Options Trading Strategies

Bearish options trading strategies are likely to be used when markets follow a bearish market trend. Here are some key methods used to trade in bearish markets: 

1. Bear Call Spread 

Considered an options trading strategy that has a double nature, in this technique, the trader sells a call option with a shorter term and simultaneously buys a call option with a longer term but both have the same underlying asset and the same expiry dates. However, the options contract with the longer term has a higher strike price. A net profit can be made by receiving a higher option premium on the call the trader sold compared to the cost of the call the trader bought. 

2. Bear Put Spread 

A trader will attempt a bear put spread as an options trading strategy if they have a slightly bearish market outlook. Here, traders predict that the price of an asset will experience a minor decline. In the bear put spread, a trader will buy put options and sell the same quantity of put options with the same underlying asset and the same date of expiry. However, the selling of put options is done at a relatively lower strike price than the put options that are bought. 

The difference between the strike prices minus the total options’ cost is the maximum profit that can be realised. 

3. Strip 

In any options for beginners guide, you may find options strategies that help you in different trading scenarios. One strategy is used in both bullish and bearish scenarios. If an investor has a bullish sentiment on volatility and a bearish prediction for the market’s direction, they may use the strip technique. Here, a trader buys two lots of at-the-money put options and at-the-money call options. In both, the underlying asset and the date of expiry are identical. Substantial returns are achieved if the underlying asset makes a relevant move on the date of expiry, shifting positively in the direction of a loss. 

4. Synthetic Put 

The synthetic put tactic entails a trader holding a long call option and a short stock position on the very same stock. If traders are betting on a bearish stock but have concerns about the stock’s strength in the short term, they use this options trading strategy. 

Neutral Options Trading Strategies

Some neutral option trading strategies may be used according to different markets and situations. These neutral strategies may be employed when traders see an opportunity that affords the use of any of these techniques: 

1. Long and Short Straddles 

Commonly used in the Indian markets, these tactics are employed by traders as they are simple to grasp. For instance, in a long straddle, whichever way the market moves (but a movement is necessary), a trader buys a long call and a long put. In a short straddle, the trader buys a short call and a short put with the same expiry date, strike price, and underlying asset. This option trading strategy is used when the market is the least volatile. 

2. Long and Short Strangles

Used as a trading method for high-volatility stock in the short term, the trader employs the long strangle when they wish to exert low risk but make high returns. The trader purchases slightly out-of-the-money put options and call options having identical underlying assets and expiry dates. Both these are bought simultaneously. When the underlying security shifts significantly higher or lower at the expiry, the most loss is limited to the premium paid, but the most profit realised can be substantial. 

The short strangle is an options trading strategy that has the objective of increasing profits for option sellers. Breakeven points are made wide and this implies more of a change in the underlying security. 

Intraday Options Trading Strategies 

Intraday trading in options contracts may seem tricky as trades are opened and closed on the same trading day. Day trading is risky and you must have a thorough understanding of it before you begin. However, you can start with small sums and go bigger as you explore this potentially profitable trading activity under options trading. Here are some hints to get you started: 

1. Momentum Trading

Here, traders tend to trade according to market momentum, tracking the appropriate stocks before any shift in momentum occurs. If a momentum change is predicted for certain stocks, traders try to capitalise on this by trading in that stock according to changes. Intraday traders must be aware of news and other events that cause the momentum of certain stocks to change and opt for options that maximise profit with minimal risk. 

2. Breakout Trading 

As an intraday strategy, this is quite popular as traders attempt to locate stocks that have broken out of the price band in which they regularly trade. If the prices of stocks increase beyond certain thresholds, intraday traders can trade their options with long positions and buy shares. 

3. Other Intraday Strategies 

Several other intraday strategies exist for trading options, and if you wish to adopt option strategies for these, you must study them thoroughly. For instance, the reversal strategy involves some risk and you have to make decisions contrary to market trends. Yet other strategies like scalping permit you to make trading decisions based on minor fluctuations in prices. Additionally, the moving average crossover strategy, famous on Indian trading platforms, lets traders bet on prices moving above and below the moving average. 

Conclusion 

The key option trading strategies have been discussed and some implications have been put forth. However, to indulge in options trading, traders must have a sound knowledge of the markets, how prices of underlying assets may fluctuate, and when to enter and exit contracts. Besides this, traders must assess their own financial goals and profiles before trading begins.