Option Trading Strategies
Usually those talking about option trading strategies speak of techniques that are used when purchasing options on stocks. An option on a stock is the right to buy or sell a certain underlying stock for a fixed price, strike price, on or before a set date.
In order to determine your next move, you have to research and analyze the movements of your underlying stock. An underlying stock, is the stock that you may buy or sell based on your option stocks. In reality, the value of your option stock is derived from the value of its underlying stocks, that is why stock options are also called derivatives.
There are three basic option trading strategies, the bullish strategy, the bearish strategy and the neutral or non-directional strategy.
The bullish strategy is used when you expect the price of the underlying stock options to go up. It could mean reduce cost for the buyer, however, the risk will always be there since when your stock options expire, the underlying stock might go down rendering it of little or no value at all. Examples may include bull call spread or bull put spread.
The bearish strategy is the opposite of the bullish strategy as in this case you expect the price of the underlying stock to go down. One good example is the put buying strategies of option traders. You have to make sure that the decline in stock prices would continue till the expiration of your stock options as it could suddenly go up.
The neutral strategy on the other hand does not depend on whether the stock prices would go up or down. That is why it is also called non-directional strategies. Instead they depend on the trait of the stocks to change its price all of a sudden, we call this trait its volatility.
One example of a neutral strategy is called a straddle, wherein you have both a pull and a call in the same strike price. Therefore whether the price increases or decreases you are still in the position to win, if the stock has a larger move than the option market predicts. Another version of this strategy is the strangle wherein you buy a call and a put simultaneously but at different strike price, this requires a larger move to be profitable but is of lower cost, and if you are profitable you will have a larger percentage gain per dollar risked than the straddle. A strangle is said to be an “explosive” stock trading strategy.
Aside from smart money management strategies, in order to do well in options trading you have analyze well the movements of your underlying stocks because this is where your option trading strategies rely on. So just as in stock trading strategies, you should rely on good fundimental analysis and technical analysis when choosing the option trading strategies that works for you.
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