Some traders tend to make a foray into options trading with barely any understanding of the strategies that can be put to use. There are a slew of options strategies that help the investors increase their gains while minimising risks at the same time.
However, it is imperative to first understand the nitty-gritties of these strategies which these stock options offer. Here, we give a lowdown on the two most common options trading strategies:
Covered call strategy
There is one strategy wherein, a trader writes a call option — which means the trader sells the ‘right to buy’ to an options holder, earning some premium in the process. This is a common strategy since it helps traders earn income and also reduces the risk of being tied to the stock for long. The only risk is that the trader has no choice but to sell shares at a pre-decided strike price, which might appear moderate in the bullish time. This is how the strategy works: you buy the securities just as you would, and at the same time write (sell) a call option on the same shares.
For instance, for every set of 100 shares of company ABC that a trader buys, they would also sell a call option against it. This options strategy is known as a covered call because the short call (in case of price rise) is covered by the long stock position.
Key advantages: In this strategy, a trader gets to earn income through premium and they also manage to protect their securities against a possible fall in the price of security.
Married put strategy
In a married put strategy, an investor buys shares and, at the same time, also buys put options for an equivalent number of units. The holder of the put option has a right to sell stock at the strike price, with each contract worth 100 shares.
A trader or investor may go for this strategy as a way to protect their securities from losses when holding a stock. This strategy is seen similar to an insurance policy since it assures the minimum price at which the trader would sell their securities in case of sharp decline in prices.
For instance, a trader buys 100 shares and also buys one put option at the same time. This strategy sounds attractive because the trader protects their securities from the decline while taking part in every growth opportunity in case of rise in stock prices. However, there is one disadvantage of this options strategy: in case stock prices do not decline, the investor would lose the premium paid to buy the put option.
As a matter of fact, there are several such options strategies that are useful in a particular set of circumstances. So, it is vital to first know the nuances of these strategies before you decide to follow any of them.