Options trading strategies is something that you should
learn if you are an options traders. Now if it be Index Options like BankNifty
Options and Nifty50 or NIFTY Option or stock options of your favourite NSE
stock. Option trading is more than buying a Call Option or Put Option.
Here you will learn about different profit making options
trading strategies to help you cutting your losses and making good profit.
If you are new to stock options please prefer reading the What Are Stock Options? before moving forward. If
you need a good stock broker or broking house to help you trade with minimum
brokerage then Open Account with Zerodha because options trading is known for
limited loss and unlimited profit but that profit will not be huge if you are
going to lose money in brokerage! So Open Account with Zerodha.
Now let’s talk about the strategies we have in this
section:
- Long Call
- Long Put
- Short Call
- Short Put
- Long Combo
- Protective Call
- Synthetic Long Call
- Covered Call
- Covered Put
- Collar
- Bear Call Spread Strategy
- Bear Put Spread Strategy
- Bull Call Spread Strategy
- Bull Put Spread Strategy
- Long Call Butterfly
- Short Call Butterfly
- Long Call Condor
- Short Call Condor
- Long Straddle
- Short Straddle
- Long Strangle
- Short Strangle
Long Call:
If you are aggressive or very bullish about the stock/index,
buying calls can be an excellent way to capture the upside potential with
limited downside risk. This is the most common Call Option trading.
Buying a call is the most basic of all options strategies.
It constitutes the first options trade for someone already familiar with buying/selling
stocks and would now want to trade options. Buying a call is an easy strategy
to understand. When you buy it means you are bullish. Buying a Call means you
are very bullish and expect the underlying stock/index to rise in future.
When to Use: Trader is very bullish on the stock/index.
Risk: Limited to the Premium. (Maximum loss if market expires
at or below the option strike price).
Reward: Unlimited
Breakeven: Strike Price +Premium
Long Put:
Buying a Put is the opposite of buying a Call. When you
buy a Call you are bullish about the stock/index. When you are bearish, you can
buy a Put option. A Put Option gives the buyer of the Put a right to sell the
stock (to the Put seller) at a pre-specified price and thereby limit his risk.
A long Put is a Bearish strategy. To take advantage of a
falling market where you can buy Put options.
When to Use: Trader is bearish about the stock/index.
Risk: Limited to the amount of Premium paid. (Maximum loss if stock/index
expires at or above the option strike price).
Reward: Unlimited
Breakeven Point: Stock Price - Premium
Short Call:
When you buy a Call you are hoping that the underlying
stock/index would rise. When you expect the underlying stock/index to fall you
do the opposite.
When a trader is very bearish about a stock/index and
expects the prices to fall, he can sell Call options. This position offers
limited profit potential and the possibility of large losses on big advances in
underlying prices. Although easy to execute it is a risky strategy since the
seller of the Call is exposed to unlimited risk.
A Call option means an Option to buy. Buying a Call option
means you expect the underlying price of a stock/index to rise in future.
Selling a Call option is just the opposite of buying a Call option. Here the
seller of the option feels the underlying price of a stock/index is set to fall
in the future.
When to Use: If you are very aggressive bearish about the stock/index.
Risk: Unlimited
Reward: Limited to the amount of premium
Breakeven Point: Strike Price + Premium
Short Put:
Selling a Put is opposite of buying a Put. A trader buys
Put when he is bearish on a stock. A trader Sells Put when he is Bullish about
the stock – expects the stock price to rise or stay sideways at the minimum.
When you sell a Put, you earn a Premium (from the buyer of
the Put). You have sold someone the right to sell you the stock at the strike
price. If the stock price increases beyond the strike price, the short put
position will make a profit for the seller by the amount of the premium, since
the buyer will not exercise the Put option and the Put seller can retain the
Premium (which is his maximum profit). But, if the stock price decreases below
the strike price, by more than the amount of the premium, the Put seller will
lose money.
The potential loss being unlimited (until the stock price
fall to zero).
When to Use: Trader is very Bullish on the stock/index. The main idea
is to make a short term income.
Risk: Put Strike Price – Put Premium.
Reward: Limited to the amount of Premium received.
Breakeven: Put Strike Price – Premium
LONG COMBO:
A Long Combo is a Bullish strategy. If a trader is expecting
the price of a stock to move up he can do a Long Combo strategy. It involves
selling an OTM (lower strike) Put and buying an OTM (higher strike) Call. This
strategy simulates the action of buying a stock (or a futures) but at a
fraction of the stock price. It is an inexpensive trade, similar in pay-off to
Long Stock, except there is a gap between the strikes. As the stock price rises
the strategy starts making profits.
When to Use: Trader is Bullish on the stock.
Risk: Unlimited (Lower Strike + net debit)
Reward: Unlimited
Breakeven: Higher strike + net debit
PROTECTIVE CALL:
This is a strategy wherein a trader has gone short on a
stock and buys a call to hedge. A trader shorts a stock and buys an ATM or
slightly OTM Call. The net effect of this is that the trader creates a pay-off
like a Long Put, but instead of having a net debit (paying premium) for a Long
Put, he creates a net credit (receives money on shorting the stock).
In case the stock price falls the trader gains in the
downward fall in the price. However, incase there is an unexpected rise in the
price of the stock the loss is limited. The pay-off from the Long Call will
increase thereby compensating for the loss in value of the short stock position.
This strategy hedges the upside in the stock position while retaining downside
profit potential.
SYNTHETIC LONG
CALL:
In this strategy, we purchase a stock since we feel
bullish about it. But what if the price of the stock went down. You wish you
had some insurance against the price fall. So buy a Put on the stock. This
gives you the right to sell the stock at a certain price which is the strike
price. The strike price can be the price at which you bought the stock (ATM
strike price) or slightly below (OTM strike price).
In case the price of the stock rises you get the full
benefit of the price rise. In case the price of the stock falls, exercise the
Put Option (remember Put is a right to sell). You have capped your loss in this
manner because the Put option stops your further losses. It is a strategy with
a limited loss and (after subtracting the Put premium) unlimited profit (from
the stock price rise).
The result of this strategy looks like a Call Option Buy
strategy and therefore is called a Synthetic Call! But the strategy is not Buy
Call Option. Here you have taken an exposure to an underlying stock with the
aim of holding it and reaping the benefits of price rise, dividends, bonus
rights etc. and at the same time insuring against an adverse price movement. In
simple buying of a Call Option, there is no underlying position in the stock
but is entered into only to take advantage of price movement in the underlying
stock.
When to Use: When ownership is desired of stock yet trader is
concerned about near-term downside risk. The outlook is conservatively bullish.
Risk: Losses limited to Stock price + Put Premium – Put Strike
price
Reward: Profit potential is unlimited.
Breakeven Point: Put Strike Price + Put Premium + Stock Price – Put Strike
Price
Covered Call:
You own shares in a company which you feel may rise but
not much in the near term (or at best stay sideways). You would still like to
earn an income from the shares. The covered call is a strategy in which an trader
Sells a Call option on a stock he owns (netting him a premium). The Call Option
which is sold in usually an OTM Call. The Call would not get exercised unless
the stock price increases above the strike price. Till then the trader in the
stock (Call seller) can retain the Premium with him. This becomes his income
from the stock. This strategy is usually adopted by a stock owner who is
Neutral to moderately Bullish about the stock.
An trader buys a stock or owns a stock which he feels is
good for medium to long term but is neutral or bearish for the near term. At
the same time, the trader does not mind exiting the stock at a certain price
(target price). The trader can sell a Call Option at the strike price at which
he would be fine exiting the stock (OTM strike). By selling the Call Option the
trader earns a Premium. Now the position of the trader is that of a Call Seller
who owns the underlying stock. If the stock price stays at or below the strike
price, the Call Buyer (refer to Strategy 1) will not exercise the Call. The
Premium is retained by the trader.
In case the stock price goes above the strike price, the
Call buyer who has the right to buy the stock at the strike price will exercise
the Call option. The Call seller (the trader) who has to sell the stock to the
Call buyer will sell the stock at the strike price. This was the price which
the Call seller (the trader) was anyway interested in exiting the stock and now
exits at that price. So besides the strike price which was the target price for
selling the stock, the Call seller (trader) also earns the Premium which
becomes an additional gain for him. This strategy is called as a Covered Call
strategy because the Call sold is backed by a stock owned by the Call Seller (trader).
The income increases as the stock rises, but gets capped after the stock
reaches the strike price.
When to Use: This is often employed when an trader has a short-term
neutral to moderately bullish view on the stock he holds. He takes a short
position on the Call option to generate income from the option premium. Since
the stock is purchased simultaneously with writing (selling) the Call, the
strategy is commonly referred to as “buy-write”.
Risk: If the Stock Price falls to zero, the trader loses the
entire value of the Stock but retains the premium, since the Call will not be
exercised against him. So maximum risk = Stock Price Paid – Call Premium Upside
capped at the Strike price plus the Premium received. So if the Stock rises
beyond the Strike price the trader (Call seller) gives up all the gains on the
stock.
Reward: Limited to (Call Strike Price – Stock Price paid) +
Premium received Breakeven: Stock Price paid -Premium Received.
COVERED PUT:
This strategy is opposite to a Covered Call. A Covered
Call is a neutral to bullish strategy, whereas a Covered Put is a neutral to
Bearish strategy.
You do this strategy when you feel the price of a
stock/index is going to remain range bound or move down. Covered Put writing
involves a short in a stock/index along with a short Put on the options on the
stock/index. The Put that is sold is generally an OTM Put. The trader shorts a
stock because he is bearish about it, but does not mind buying it back once the
price reaches (falls to) a target price. This target price is the price at
which the trader shorts the Put (Put strike price). Selling a Put means, buying
the stock at the strike price if exercised.
If the stock falls below the Put strike, the trader will
be exercised and will have to buy the stock at the strike price (which is
anyway his target price to repurchase the stock). The trader makes a profit
because he has shorted the stock and purchasing it at the strike price simply
closes the short stock position at a profit. And the trader keeps the Premium
on the Put sold. The trader is covered here because he shorted the stock in the
first place. If the stock price does not change, the trader gets to keep the
Premium. He can use this strategy as an income in a neutral market.
When to Use: If the trader is of the view that the markets are
moderately bearish.
Risk: Unlimited if the price of the stock rises substantially
Reward: Maximum is (Sale Price of the Stock – Strike Price) + Put
Premium
Breakeven: Sale Price of Stock + Put Premium
Collar:
A Collar is similar to Covered Call but involves another
leg – buying a Put to insure against the fall in the price of the stock. It is
a Covered Call with a limited risk. So a Collar is buying a stock, insuring
against the downside by buying a Put and then financing (partly) the Put by
selling a Call.
The put generally is ATM and the call is OTM having the
same expiration month and must be equal in number of shares. This is a low risk
strategy since the Put prevents downside risk. However, do not expect unlimited
rewards since the Call prevents that. It is a strategy to be adopted when the trader
is conservatively bullish.
When to Use: The collar is a good strategy to use if the trader is
writing covered calls to earn premiums but wishes to protect himself from an
unexpected sharp drop in the price of the underlying security.
Risk: Limited
Reward: Limited
Breakeven: Purchase Price of Underlying – Call Premium + Put Premium
BEAR CALL SPREAD
STRATEGY:
The Bear Call Spread strategy can be adopted when the trader
feels that the stock/index is either range bound or falling.
The concept is to protect the downside of a Call Sold by
buying a Call of a higher strike price to insure the Call sold. In this
strategy the trader receives a net credit because the Call he buys is of a
higher strike price than the Call sold.
The strategy requires the trader to buy out-of-the-money
(OTM) call options while simultaneously selling in-the-money (ITM) call options
on the same underlying stock index. This strategy can also be done with both
OTM calls with the Call purchased being higher OTM strike than the Call sold.
If the stock/index falls both Calls will expire worthless
and the trader can retain the net credit. If the stock/index rises then the
breakeven is the lower strike plus the net credit. Provided the stock remains
below that level, the trader makes a profit. Otherwise he could make a loss.
The maximum loss is the difference in strikes less the net credit received.
When to Use: When the trader is mildly bearish on market.
Risk: Limited to the difference between the two strikes minus
the net premium.
Reward: Limited to the net premium received for the position
i.e., premium received for the short call minus the premium paid for the long
call.
Breakeven: Lower Strike + Net credit
BEAR PUT SPREAD
STRATEGY:
This strategy requires the trader to buy an in-the-money
(higher) put option and sell an out-of-the-money (lower) put option on the same
stock with the same expiration date. This strategy creates a net debit for the trader.
The net effect of the strategy is to bring down the cost
and raise the breakeven on buying a Put (Long Put).
The strategy needs a Bearish outlook since the trader will
make money only when the stock price/index falls. The bought Puts will have the
effect of capping the trader’s downside. While the Puts sold will reduce the traders
costs, risk and raise breakeven point (from Put exercise point of view).
If the stock price closes below the out-of-the-money
(lower) put option strike price on the expiration date, then the trader reaches
maximum profits. If the stock price increases above the in-the-money (higher)
put option strike price at the expiration date, then the trader has a maximum
loss potential of the net debit.
When to Use: When you are moderately bearish on market direction
Risk: Limited to the net amount paid for the spread. i.e. the
premium paid for long position less premium received for short position.
Reward: Limited to the difference between the two strike prices
minus the net premium paid for the position.
Breakeven: Strike Price of Long Put – Net Premium Paid
BULL CALL SPREAD
STRATEGY:
A bull call spread is constructed by buying an
in-the-money (ITM) call option, and selling another out-of-the-money (OTM) call
option.
Often the call with the lower strike price will be
in-the-money while the Call with the higher strike price is out-of-the-money.
Both calls must have the same underlying security and expiration month.
The net effect of the strategy is to bring down the cost
and breakeven on a Buy Call (Long Call) Strategy. This strategy is exercised
when trader is moderately bullish to bullish, because the trader will make a
profit only when the stock price/index rises. If the stock price falls to the
lower (bought) strike, the trader makes the maximum loss (cost of the trade)
and if the stock price rises to the higher (sold) strike, the trader makes the
maximum profit.
When to Use: Trader is moderately bullish.
Risk: Limited to any initial premium paid in establishing the
position. Maximum loss occurs where the underlying falls to the level of the
lower strike or below.
Reward: Limited to the difference between the two strikes minus
net premium cost. Maximum profit occurs where the underlying rises to the level
of the higher strike or above.
Breakeven: Strike Price of Purchased call + Net Debit Paid
BULL PUT SPREAD
STRATEGY:
A bull put spread can be profitable when the stock/index
is either range bound or rising. The concept is to protect the downside of a
Put sold by buying a lower strike Put, which acts as an insurance for the Put
sold. The lower strike Put purchased is further OTM than the higher strike Put
sold ensuring that the trader receives a net credit, because the Put purchased
(further OTM) is cheaper than the Put sold.
This strategy is equivalent to the Bull Call Spread but is
done to earn a net credit (premium) and collect an income. If the stock/index
rises, both Puts expire worthless and the trader can retain the Premium. If the
stock/index falls, then the trader’s breakeven is the higher strike less the
net credit received. Provided the stock remains above that level, the trader
makes a profit. Otherwise he could make a loss. The maximum loss is the
difference in strikes less the net credit received. This strategy should be
adopted when the stock/index trend is upward or range bound.
When to Use: When the trader is moderately bullish.
Risk: Limited. Maximum loss occurs where the underlying falls
to the level of the lower strike or below.
Reward: Limited to the net premium credit. Maximum profit occurs
where underlying rises to the level of the higher strike or above.
Breakeven: Strike Price of Short Put - Net Premium Received.
LONG CALL
BUTTERFLY:
A Long Call Butterfly is to be adopted when the trader is
expecting very little movement in the stock price/index. The trader is looking
to gain from low volatility at a low cost. The strategy offers a good
risk/reward ratio, together with low cost.
The strategy can be done by selling 2 ATM Calls, buying 1
ITM Call, and buying 1 OTM Call options (there should be equidistance between
the strike prices). The result is positive in case the stock/index remains
range bound. The maximum reward in this strategy is however restricted and
takes place when the stock/index is at the middle strike at expiration. The
maximum losses are also limited.
When to Use: When the trader is neutral on market direction and
bearish on volatility.
Risk: Net debit paid.
Reward: Difference between adjacent strikes minus net debit
Breakeven:
Upper Breakeven Point = Strike Price of Higher Strike Long
Call – Net Premium Paid
Lower Breakeven Point = Strike Price of Lower Strike Long
Call + Net Premium Paid
SHORT CALL
BUTTERFLY:
A Short Call Butterfly is a strategy for volatile markets.
It is the opposite of Long Call Butterfly, which is a range bound strategy. The
Short Call Butterfly can be constructed by Selling one lower striking
in-the-money Call, buying two at-the-money Calls and selling another higher
strike out-of-the-money Call, giving the trader a net credit (therefore it is
an income strategy).
There should be equal distance between each strike. The
resulting position will be profitable in case there is a big move in the
stock/index. The maximum risk occurs if the stock/index is at the middle strike
at expiration. The maximum profit occurs if the stock finishes on either side
of the upper and lower strike prices at expiration.
When to Use: You are neutral on market direction and bullish on
volatility. Neutral means that you expect the market to move in either
direction - i.e. bullish and bearish.
Risk: Limited to the net difference between the adjacent
strikes less the premium received for the position.
Reward: Limited to the net premium received for the option
spread.
Breakeven:
Upper Breakeven Point = Strike Price of Highest Strike
Short Call - Net Premium Received
Lower Breakeven Point = Strike Price of Lowest Strike
Short Call + Net Premium Received
LONG CALL CONDOR:
A Long Call Condor is very similar to a long butterfly
strategy. The difference is that the two middle sold options have different
strikes. The profitable area of the payoff profile is wider than that of the
Long Butterfly.
The strategy is suitable in a range bound market. The Long
Call Condor involves buying 1 ITM Call (lower strike), selling 1 ITM Call
(lower middle), selling 1 OTM call (higher middle) and buying 1 OTM Call
(higher strike).
The long options at the outside strikes ensure that the
risk is capped on both the sides. The resulting position is profitable if the
stock/index remains range bound and shows very little volatility. The maximum
profits occur if the stock finishes between the middle strike prices at
expiration.
When to Use: When an trader believes that the underlying market will
trade in a range with low volatility until the options expire.
Risk: Limited to the minimum of the difference between the
lower strike call spread less the higher call spread less the total premium
paid for the condor.
Reward: Limited. The maximum profit of a long condor will be
realized when the stock is trading between the two middle strike prices.
Breakeven:
Upper Breakeven Point = Highest Strike – Net Debit
Lower Breakeven Point = Lowest Strike + Net Debit
SHORT CALL CONDOR:
A Short Call Condor is very similar to a short butterfly
strategy. The difference is that the two middle bought options have different
strikes. The strategy is suitable in a volatile market.
The Short Call Condor involves selling 1 ITM Call (lower
strike), buying 1 ITM Call (lower middle), buying 1 OTM call (higher middle)
and selling 1 OTM Call (higher strike). The resulting position is profitable if
the stock/index shows very high volatility and there is a big move in the
stock/index.
The maximum profits occur if the stock/index finishes on
either side of the upper or lower strike prices at expiration.
When to Use: When an trader believes that the underlying market will
break out of a trading range but is not sure in which direction.
Risk: Limited. The maximum loss of a short condor occurs at the
center of the option spread.
Reward: Limited. The maximum profit of a short condor occurs when
the underlying stock/index is trading past the upper or lower strike prices.
Breakeven:
Upper Breakeven Point = Highest Strike – Net Credit
Lower Breakeven Point = Lowest Strike + Net Credit
LONG STRADDLE:
A Straddle is a volatility strategy and is used when the
stock price/index is expected to show large movements.
This strategy involves buying a call as well as put on the
same stock/index for the same maturity and strike price, to take advantage of a
movement in either direction, a soaring or plummeting value of the stock/index.
If the price of the stock/index increases, the call is exercised while the put
expires worthless and if the price of the stock/index decreases, the put is
exercised, the call expires worthless.
Either way if the stock/index shows volatility to cover
the cost of the trade, profits are to be made. With Straddles, the trader is
direction neutral. All that he is looking out for is the stock/index to break
out exponentially in either direction.
When to Use: The trader thinks that the underlying stock/index will
experience significant volatility in the near term.
Risk: Limited to the initial premium paid.
Reward: Unlimited
Breakeven:
Upper Breakeven Point = Strike Price of Long Call + Net
Premium Paid
Lower Breakeven Point = Strike Price of Long Put - Net
Premium Paid
SHORT STRANGLE:
This strategy involves the simultaneous selling of a
slightly out-of-the-money (OTM) put and a slightly out-of-the-money (OTM) call
of the same underlying stock and expiration date. This typically means that
since OTM call and put are sold, the net credit received by the seller is less
as compared to a Short Straddle, but the break even points are also widened.
The underlying stock has to move significantly for the
Call and the Put to be worth exercising. If the underlying stock does not show
much of a movement, the seller of the Strangle gets to keep the Premium.
It tries to improve the profitability of the trade for the
Seller of the options by widening the breakeven points so that there is a much
greater movement required in the underlying stock/index, for the Call and Put
option to be worth exercising.
When to Use: This options trading strategy is taken when the options trader
thinks that the underlying stock will experience little volatility in the near
term.
Risk: Unlimited
Reward: Limited to the premium received
Breakeven:
Upper Breakeven Point = Strike Price of Short Call + Net
Premium Received
Lower Breakeven Point = Strike Price of Short Put - Net
Premium Received
LONG STRANGLE:
A Strangle is a slight modification to the Straddle to
make it cheaper to execute. This strategy involves the simultaneous buying of a
slightly out-of-the-money (OTM) put and a slightly out-of-the-money (OTM) call
of the same underlying stock/index and expiration date. Here again the trader
is directional neutral but is looking for an increased volatility in the
stock/index and the prices moving significantly in either direction.
Since OTM options are purchased for both Calls and Puts it
makes the cost of executing a Strangle cheaper as compared to a Straddle, where
generally ATM strikes are purchased. Since the initial cost of a Strangle is
cheaper than a Straddle, the returns could potentially be higher.
However, for a Strangle to make money it would require
greater movement on the upside or downside for the stock/index than it would
for a Straddle. As with a Straddle, the strategy has a limited downside (i.e.
the Call and the Put premium) and unlimited upside potential.
When to Use: The trader thinks that the underlying stock/index will
experience very high levels of volatility in the near term.
Risk: Limited to the initial premium paid
Reward: Unlimited
Breakeven:
Upper Breakeven Point = Strike Price of Long Call + Net
Premium Paid
Lower Breakeven Point = Strike Price of Long Put - Net
Premium Paid
SHORT STRADDLE:
A Short Straddle is the opposite of Long Straddle. It is a
strategy to be adopted when the trader feels the market will not show much
movement. He sells a Call and a Put on the same stock/index for the same
maturity and strike price. It creates a net income for the trader.
If the stock/index does not move much in either direction,
the trader retains the Premium as neither the Call nor the Put will be
exercised. However, in case the stock/index moves in either direction, up or
down significantly, the trader’s losses can be significant.
So this is a risky strategy and should be carefully
adopted and only when the expected volatility in the market is limited. If the
stock/index value stays close to the strike price on expiry of the contracts,
maximum gain, which is the Premium received is made.
When to Use: The trader thinks that the underlying stock/index will
experience very little volatility in the near term.
Risk: Unlimited
Reward: Limited to the premium received
Breakeven:
Upper Breakeven Point = Strike Price of Short Call + Net
Premium Received
Lower Breakeven Point = Strike Price of Short Put - Net
Premium Received
Hope these strategies help you with money making! Happy
trading and if you need a good stock broker or broking house to help you trade
with minimum brokerage then Open Account with Zerodha because options trading is known for
limited loss and unlimited profit but that profit will not be huge if you are
going to lose money in brokerage! So Open Account with Zerodha.