4 Popular Options Strategies for Beginners
To understand option strategies, you must first have a clear understanding of call and put options.
A call option is usually purchased if the investor expects the price of the stock to increase within a certain amount of time. This type of options contract gives the buyer of the contract the right to buy the stock at the strike price at any time up to the expiration date of the agreement. The seller or writer of the call option receives the premium paid by the buyer when entering the deal.
A put option is an option contract that gives the owner the right but does not obligate the owner to sell an underlying security at a specified price within a specified time frame. This type of option becomes more valuable as the price of the underlying stock moves below the strike price. Therefore, it loses value as the underlying stock increases. As most options do, put options also decrease in value as the expiration date nears.
The intention with the use of the covered call strategy is to collect money from the options premiums by selling against a stock that the investor already owns. If the stock does not move above the strike price of the contract, the trader can collect the premium and can still keep his or her stock position. This is done by purchasing stocks or using one that is already owned. The investor sells the call options for the same or lower price of the security, then waits for the options contract to be exercised or expire. If the options contract is executed the trader will sell the asset at the strike price but if the deal is not completed and just expires the trader keeps the stock.
Depending on the trader’s plan there are two ways to profit from the selling of covered calls. If the investor wishes to earn an income on the stock, then he or she would want the underlying to remain close to the strike price without going above it. If the trader wishes to sell the stock while making additional profit by selling the call options, he or she would want the security to move above the strike price and stay there until the options contracts expire.
The risk of using a covered call strategy comes mainly with owning the stock as it can lose value.
Used to protect traders from possible short-term losses a married put is often considered a type of insurance for investors. Utilized mainly during bullish outlooks a married put protects the value of the stock in the case of a downward turn in the market.
This type of option strategy position is created by an investor must purchasing the underlying stock and also buying a call put option at a strike price lower than the current stock price. By owning both the put and the underlying security, the investor is protected from any downside price movements below the put’s strike price. This protection comes as the investor now has the right to exercise the put and sell the stock.
The Married Put strategy differs from other bullish options strategies in that it involves actually buying the underlying stock as opposed to only trading the options. Therefore, to earn the same profits as a trader who only bought the stock more upward movement is required to cover the cost of the premium of the option. However, if the stock price falls, your profit will decrease and can become a loss. Once the stock price falls below the put option’s strike price, the loss will be confined. The put option will then become in-the-money, increasing in value the lower the underlying stock price gets, stopping further losses. The most that an investor can lose on a protective put is the difference between what he or she paid for the stock and the strike price of the put, plus the premium paid for the put option.
Often used as replacements for stop orders, married puts give traders more control over when they can exercise their option, and the amount that will be received for the stock is predetermined.
The intent with this strategy is to buy a stock at a lower price than what it is currently trading at in the market. In this case, an investor believes that the security will eventually increase in price but does not want to buy it at its current market price. He or she can sell put options. The hope is for the stock to make a bearish move and fall below the strike price of the options and remain there. When the contract expires, the investor is then assigned the underlying asset at the new lower rate. The premium from the selling of the put option is then used to offset the price of the stock to be purchased. In this scenario, the investor would have already deposited enough funds into his or her account to complete the purchase of the security.
You can think of a collar as running a double play because you are using two strategies, a protective put and a covered call. A protective put operates the same as married put except the investor is not buying a stock at the same time. Investors create collar positions by purchasing an out-of-the-money put option while also selling an out-of-the-money call option. The put option is what protects the trade from a price drop in the market. The call option offsets the price of the put option with the collection of its premium and allows the trader to generate income on the asset until it reaches its strike price. The call you sell caps the upside. If the stock has exceeded strike B by expiration, it will most likely be called away. So, you must be willing to sell it at that price.