Traders are seen jumping onto trading options while possessing little understanding of the strategies available to them. While multiple-option strategies limit the risk involved and maximize returns, you need to learn how to take advantage of stock options' power and flexibility.

So, let's look at 12 options strategies that all traders need to know.

What are Options Trading? 

Options trading is the method used by investors to speculate the future direction of overall stock markets or individual securities like bonds and stocks. Options trading gives you a choice but not an obligation to buy or sell underlying assets at specific prices on a particular date. 

Options are tradable contracts that investors use to speculate whether the asset prices are higher or lower on a specific date in the future without buying the asset in question. 

For example, Nifty 50 options allow traders to speculate the future direction of the benchmark stock index, commonly understood as stand-ins for the whole stock market. 

Key Terms to Explain Options Trading

• Derivative: Options are also known as derivatives, meaning they get their value from another asset. It takes stock options, where the prices of a given stock dictate the total value of options. 

• Call option and Put option: The Call Option allows you to buy securities at predetermined prices within a specific date, while put options will enable you to sell securities for a future price and date. 

• Strike price and expiry date: The predetermined price mentioned in the previous text is the strike price. Traders have time until the expiration date to exercise the strike price options. 

• Premium: The price at which the purchase of an option occurs is a premium. It is calculated based on the underlying security price and value. 

• Intrinsic and extrinsic value: Intrinsic value is the difference between option contract strike prices and current prices of underlying assets. At the same time, the extrinsic value represents factors other than those in intrinsic value that affect premiums, for example, how long the options last. 

• In-money and out-of-money: Depending on the total security price and the time remaining for expiration, an option can be Profitable or In-The-Money and Unprofitable or Out-Of-The-Money.

How does Options Trading Work?

There is a wide range of options trading strategies and a more straightforward approach to complicated trades. In other words, trading call options are wagers on rising prices, while trading put options are the best way to bet on falling prices. 

Options trading provides investors with the right to sell or buy a minimum of 100 stocks or assets. But there is no obligation to exercise such options if the trade does not yield a profit. Choosing not to exercise any options means the only money an investor loses is the premium paid. Because of this, options trading is relatively low-cost as it is the best way to speculate the entire range of assets. 

With options trading, you can speculate: 

• If asset prices increase or fall from the current price.

• By how much will asset prices rise or fall.

• By which date will such price changes occur.

With options such as call and put, you will need the asset prices to rise or fall to break even, which equals the premium paid + strike price. So, how do you earn profits: 

• Call options - As the underlying asset costs exceed the break-even price, you can sell your call option (called closing your position) and the difference earned between the premium paid and the current premium. Also, you can use the opportunity to buy any assets at the agreed strike price. 

• Put options - Once an asset price falls below the break-even level, you need to sell the options contract or close your position. This allows you to collect the difference between the paid and the current premium. Also, you can exercise your selling option with underlying assets at the agreed-upon strike rates. 

When your asset prices move in a different direction than the desire for a call or put option, you can let the contract expire. This way, your losses equal the amount you paid for the opportunity and not more. 

This is why options trading strategies can be very confusing, especially when traders try to pair two or more calls or puts with multiple strike prices or expiry dates.  

What are the Advantages and Disadvantages of Options Trading?

Options trading is one of the most beneficial financial options that investors can use to increase profits. 

The advantages of options trading include the following: 

• Higher leverage - Options trading has higher leveraging power that investors can take positions similar to stocks but with a reduced personal investment. They can buy assignments through leveraging offered by stockbrokers until they maintain their minimum balance in a margin account. Also, until they exercise their contract, they do not need to pay any amount to purchase the asset. 

• Predetermined pricing - When investors buy options, they fix the stock costs at predetermined prices to guarantee a specified amount once the contract is exercised. This helps them ensure that if there are any losses made from direct investments, they can square them off. 

• Limiting downside - When buying call or put options, investors can exercise their contract but are not obligated. This means that if they do not reach their desired price, they do not need to exercise the agreement to incur losses. Investors can decide against it and limit their losses to the premium amount of the option. 

The disadvantages of Options Trading include the following: 

• Total losses - Unlike buyers, options contracts can force sellers to incur losses as they must buy or sell their assets. This is because options contracts offer the right to buyers so that they can exercise their right to buy the underlying asset at predetermined costs. But this is a loss for sellers. They may not be willing to sell as they might incur losses. They are obligated to sell when buyers exercise their right to buy assets. 

• Highly Complex - For investors to be experts in options trading, they need to study the complex terminologies and strategies that are time-consuming. Since there are multiple strategies for bullish, neutral, and bearish markets, it isn't easy for traders or investors to understand them in detail.

What are the Different Types of Options Trading Strategies?

1. Bullish Options Strategies

If the market is bullish, then options trading should follow bullish options strategies to increase profits and reduce losses: 

2. Bull Call Spread

The Bull-Call spread has two call options based on different strike prices to help create a range. But both have an underlying option and an expiry date. The investor and traders need to buy only one call option, which is At-The-Money, simultaneously selling the other call option on Out-Of-The-Money. For investors, the bull-call spread strategy is profitable when the underlying assets, like stocks, surge in price.   

3. Bull Pull Spread

The Bull-put spread strategy is similar to the Bull-call spread, as investors utilize two put options with different strike rates and an expiration date to help create a range. But the investors and traders buy one single put option in the Out-Of-The-Money and sell one put option in the In-The-Money. In this strategy, investors profit once the underlying asset price increases before expiration. This strategy is mainly formed to increase net credit or the net amount received, whereas when a loss is incurred, the underlying asset costs fall below the strike price in the long-put option. 

4. Call Ration Back Spread

One of the three-legged options is where investors and traders buy two Out-Of-The-Money call options while simultaneously selling one In-the-Money call option. The profit is unlimited, whereas the loss incurred if the underlying asset cost stays in the specific range. 

5. Synthetic Call

Investors use the synthetic call when they have a bullish long-term view of the underlying asset, but at the same time, they need to worry about the downside risks. The strategy includes buying put options of the same asset through direct investment post a bullish view. The profits are unlimited when the stock prices rise, and the loss is limited to premium amounts.  

6. Bearish Options Strategies

The financial market is dynamic and contains volatility derived from various external market factors that force the market to enter a bearish trend. In these cases, the option strategy investors use the following bearish trading strategies: 

a. Bear Call Spread

The strategy involves buying one Out-Of-The-Money call option with a higher strike price while selling one In-The-Money call option with lower strike costs that come with an underlying asset and expiration date. This strategy was made for net credit so investors can profit when the asset price falls. The loss is limited between the spread and net credit.   

b. Bear Put Spread

Just like the bear pull spread, investors use this strategy when they feel that the asset costs will fall but not by a high margin. In this strategy, investors must purchase one In-The-Money put option while selling one Out-Of-The-Money put option. The profit potential remains limited to the difference between the net debit and spread, where the net debit is the difference in the premium paid and bonus received.  

7. Strip

This three-section strategy is bearish to neutral, where the investors buy one call option and put in two options with similar underlying assets, strike prices, and expiry dates at the At-The-Money stage. In this strategy, traders earn profits when the underlying asset costs fall significantly during expiration. The potential to make profits is unlimited, whereas the potential to earn loss is limited to a premium amount.      

8. Synthetic Put

Investors can use the synthetic put strategy when they see that the market is leaning towards a bearish trend, but the underlying asset loses strength in the near term. The strategy may also be known as the long synthetic put, where investors profit from a reduction in underlying asset costs. The potential to earn profits is unlimited, just like the long put, and the loss potential is the difference between the short sale price and the long call strike price. 

9. Neutral Options Strategies

The Neutral options strategy is used by investors who have no idea where the asset price will move. So, they look for neutral options strategies such as: 

a. Long and Short Straddles

The long straddle is a simple strategy for buying an In-The-Money call with put options using the same asset, strike price, and expiration date. The profit potential is unlimited, while the loss is limited. On the other hand, the short straddle is based on selling an At-The-Money call and put option for the same asset, strike price, and expiry date. In this strategy, the profit equals the received premium, whereas the loss is unlimited.  

10. Long and Short Strangles

The long strangle strategy consists of buying one Out-Of-The-Money call option and one Out-Of-The-Money put option. Here the profit is unlimited, whereas the loss is limited to the net premium. On the other hand, the short straddle uses selling one Out-Of-The-Money put and one Out-Of-The-Money call option. The maxim profit for this stage is equal to the premium received, whereas the loss is unlimited.  

11. Long and Short Butterfly: 

The long and short butterfly strategy combines bullish and bearish spreads, which have limited profits, fixed risks, and options at the same level as the At-The-Money option. The long butterfly option has to buy one In-The-Money call option, whereas selling two At-The-Money call options and then buying a single Out-Of-The-Money call option. On the other hand, the short butterfly strategy includes selling a single In-The-Money call option while buying two At-The-Money call options and then selling a single Out-Of-The-Money call option.  

12. Long and Short Iron Condor: 

The long and short iron condor strategy includes one long and one short put, along with one long and one quick call at different strike prices and expiration dates. Unlike their bull put spread, the iron strategy is a four-legged one with limited risks and benefits investors and traders from low market volatility. The profit potential is at the highest level, where the underlying asset cost is in the middle of the strike price at the expiration time. 

Conclusion

There are multiple assets, such as bonds, equities, commodities, ETFs, and others, where investors and traders can directly invest in making profits. But derivatives like options are one aspect that allows traders and investors to create a financial contract with underlying assets from multiple asset classes.

Also, options trading offers flexible options to buyers, so they have the right but no obligation to buy the assets at a predetermined price. This means that when the buyer feels that the contract is forcing them to incur losses, they can choose not to follow the agreement, thus allowing them to mitigate their losses.

Multiple option trading strategies are readily available to make investors and traders profit in market conditions. This forces investors to take a bullish approach when the market is bullish and vice versa. We hope that our guide will help you make the right decision and mitigate losses.