Options Techniques That Every Trader Should Know | Motilal Oswal

Options Techniques

Traders and investors have a way of plunging into trading in options with a meagre understanding of any options strategies which may be available. Several options strategies exist and these may go far in limiting the risks of trading in options, and maximising the returns while trading in the same. The share market today is rife with opportunities at every turn, and to make the most of these, options traders have to employ a plan to trade proficiently. By putting in a minimum of effort, traders can grasp how to make the most of the power and flexibility that stock options are likely to provide. 

Trading in Options

Trading in options contracts, in the share market today, when executed in the right way, are among the most effective and efficient ways to gain wealth over a term. You don’t even have to open a demat account to trade in options. In case you are a beginner, options strategies can help you make a start in this vehicle of investment. For seasoned traders, strategies can encourage more knowledge to better your performance. With an options contract, an investor can purchase or sell any underlying asset, like an index or a stock, at a fixed price across a set period. This is a strategy in itself for buying or selling a stock to make a profit. 

However, depending on each investor’s style and trading pattern, certain strategies appeal to particular traders and investors. If you know how these work, you will be able to select the one that matches you. If you have planned to try options trading today, there are ten efficient strategies that may make you excel. Before getting into those in detail, and which suits you when you trade in the stock market today, there is something more to know about options trading. 

Get Your Calls and Puts Straight!

The first thing you should understand about options is that they are a kind of derivative security. This is because the price of any option is related to the price of something else, an underlying asset. An options contract grants an investor a right - to purchase or sell any underlying asset at a predetermined price, on a specific date, or before that date. A call option lets an investor of the options contract have the right to purchase a stock and a put option lets an investor sell a stock. Since you don’t have to open a demat account for investing in options contracts, this is an appealing way for investors to invest. Now you can get into some fundamentals about options trading strategies. 

1. The Covered Call

If you think about call options in options trading, you can simply go in for a call option, or instead, consider a basic covered call. This is also known as a “buy write”. A popular strategy as it generates income and brings down some of the risk of being long with the stock alone, the trade-off is that you have to sell shares at a fixed price, that is, the short strike price. If you wish to employ this strategy, you purchase the stock like you would normally, and simultaneously “write’ or sell a call option on exactly the same shares. In a covered call, in case the price of the stock goes up quickly, the investor’s short call can be covered by the long position. 

Traders and investors actively use such a strategy if they hold a short-term position in a certain stock and a fairly neutral belief about the direction in which it is headed. Investors may be on the hunt to generate an income via the selling of the call premium. Alternatively, they may safeguard against a probable decline in the value of the underlying stock. 

2. The Married Put

In case you think that employing strategies is not for you and you should simply go in for an upcoming IPO subscription instead, you should give options a chance. If investing in options in the share market today, you can employ a simple strategy like a married put strategy. Here, an investor buys an asset (like shares of stock), and purchases put options with an equal amount of shares simultaneously. If you hold a put option, you have a right to sell a stock at a strike price, with every contract being worth a hundred shares. Any investor may pick such a strategy to protect their risk on the downside while a stock is held. It is also called a “protective put” as the strategy can be compared to an insurance scheme - If the price of the stock steeply falls, it creates a price floor.

The technique has a lot of appeal for traders as they are safeguarded from the downsides of trading, if there is a negative shift in the price of a particular stock. Simultaneously, traders can have the benefit of taking part in each upside opportunity in case the particular stock’s value rises. The only visible disadvantage of this technique is that in case the stock’s value fails to fall, the investor makes a loss in terms of the premium which has been paid regarding the put option. 

3. The Bull Call Spread

The bull call spread is a strategy in which an investor buys calls simultaneously at a certain strike price, and sells the exact amount of calls at a strike price which is higher. Here, both of the call options have identical dates of expiry and the same underlying asset. This is a vertical spread technique, often employed when an investor has a bullish approach with respect to the underlying asset, expecting a fair rise in the asset’s price. When traders use such a strategy, they can easily place limits on their upside of the trade in question, and at the same time, reduce the premium that may be spent (relative to purchasing a regular option call straight off). 

4. The Bear Put Spread

Another example of a strategy that executes a vertical spread, this strategy involves the investor simultaneously buying put options at a particular strike price, while engaging in the sale of the exact amount at lower strike prices. Both the options may be bought with the same expiry date and for the identical underlying assets. The trader’s bearish sentiment is what makes them employ such a strategy when the expectation of the underlying asset’s price is that of decline. Both limited gains and limited losses are provided with such a strategy. Thus far, you can see that you may invest in options trading as an alternative to simply investing in equity after you open a demat account. 

For the bear put spread to work effectively, the price of the stock has to drop. If you execute this strategy, your upside has limitations, but on the other hand, your premium may be reduced. If you find that outright puts seem expensive, a way to offset high premiums is by the sale of low strike puts. This forms the core of the construction of a bear put spread. 

5. The Protective Collar

Performed when a trader buys an OTM, or “out of the money” put option, and at the same time, writes an out of the money call option (with the same expiry date), this technique is engaged in when the investor owns the underlying asset. Regularly used by investors when a long position of a stock goes through significant gains, the strategy permits investors to have downside protection. The long put aids in locking the potential price of the sale. Nonetheless, the trade-off is represented by the fact that investors may face some obligation to sell their shares at a higher value. Consequently, they forego the chance of any further gains. In the share market today, you may find that strategies may not assure you of definite gains and they may have their flipside, but having a strategy is better than none at all. 

6. The Long Straddle

The long straddle approach is taken by investors when a put option and a call option is purchased with the identical underlying asset, the same date of expiry, and the identical strike price. Investors use this strategy quite frequently when they think that the underlying asset’s price will shift significantly beyond a particular range. As strong as this belief may be, investors may be unsure of what direction the shift may steer towards. 

In theory, this is a strategy that permits investors to use opportunities for limitless returns. However, as much as the potential returns may be, there is also the possibility of loss, and this is restricted to the value of both the contracts of options taken together. Such a strategy shows a marked profit when stocks make big shifts in one direction or another. With regard to the investor, the direction of the move does not matter. The only thing that does matter is that the shift be more than the total premium that the investor has paid in the first place. 

7. The Long Strangle

It's very easy for a novice or an expert to get confused between strategies and techniques of trading that can be engaged in the stock market today. With similar sounding terms and concepts that remain blurred unless you really do your work well, traders have been known to take a fall in the markets. The long straddle and the long strangle sound very similar, but they are different techniques to make your options trading worthwhile. In the long strangle method, the investor buys both call and put options with different strike prices. Essentially this translates to an “out of the money” call option with an “out of the money” put option. The underlying asset and the date of expiry remain the same for both. This strategy is popular with investors who feel that the price of an underlying asset will face a massive shift, but don’t know where that shift will be. 

Although the strategy sounds very similar to the long straddle, there is a difference, and this is in the distinctly different strike prices of each option type. As an instance of when the strategy is employed in the share market today, the strategy could well represent a wager based on news about an earnings release from a corporation. Another example that comes to mind would be of an event that is linked to an FDA (Food & Drug Administration) approval regarding a stock in the pharmaceutical sector. With the employment of this strategy, losses are restricted to the involved costs for both the options - that is, the premiums that have been paid. You can be rest assured that strangles will nearly always be less costly than the method of straddles. This is because the options that are bought are the out of the money options. 

It is important to note that this strategy proves profitable if the value of the stock, going up or going down, has some very large movements. Again here, the investor is not concerned about the direction of the movement, only that it moves enough to position one option or the other “within the money”. It has to amount to more than the amount paid for the premium. 

8. The Long Call Butterfly Spread

You may have noticed that all the prior strategies mentioned require a blend of two distinct positions, or rather, contracts. Regarding a long call butterfly spread, employing call options, an investor can mix a bull spread technique and a bear spread method. Along with this combination, three distinct strike prices are used. All the options are connected to the identical underlying asset and have the same expiration dates. 

In the stock market today, you can find different permutations of the strategy used very effectively. For instance, the strategy may be constructed when investors buy one “in the money” call option at a low strike price. Simultaneously, investors may sell two “at the money” call options. They may also, at the same time, purchase an “out of the money” call option. This may be a somewhat unbalanced butterfly spread. However, there can be a balanced spread with all the same wing widths. The time that an investor chooses this strategy is when they think that a stock will fail to move all that much in advance of the date of expiry. The strategy is used by investors who have a low risk appetite, and the upsides are limited and so are the downsides. 

9. The Iron Condor

The iron condor strategy involves the investor holding a bull put spread with a bear put spread at the same time. The strategy is built on the sale of an OTM (out of the money) put and the purchase of an OTM (out of the money) put with a low strike. This represents a bull put spread. Simultaneously, along with this, an OTM call is sold and an OTM call is bought at a high strike. This is representative of a bear call spread. 

In this strategy, every option has the identical date of expiry and the same asset which underlies the contract. The spread width of the put and call positions is also the same. When this trading strategy is used by investors, the net premium is earned on the structure, designed to make the most of any stock that is faced with low volatility. Several traders and investors take advantage of this strategy as it displays a perceived high potential of earning a small degree of the premium. With the iron condor, the maximum which can be lost in a trade is usually higher than the amount which is maximally gained from a trade. Intuitively, this makes good sense, as there is more probability of the structure ending with a small return. 

10. The Iron Butterfly

In the share market today, this is a technique that investors use more than the iron condor. Here, any traders or investors sell a put “at the money” and buy a put “out of the money”. At precisely the same time, traders sell a call “at the money” and buy a call “out of the money”. As with many other strategies mentioned previously, the date of expiry and the underlying asset of the contracts stay the same for both instances. The strategy appears similar to the one involving the butterfly spread, as it makes use of calls and puts (rather than one opposing the other). 

You can see that this strategy actually combines the purchase of protective “wings” and the sale of an “at the money” straddle. The construction also has to do with two spreads. It is not uncommon to have the identical width for both of the spreads. The “out of the money” long call safeguards against any unlimited downside. The “out of the money” long put can protect against any downside. The profit and loss from this structure is limited to a certain range, according to the strike prices of the used options. This is a popular strategy and is liked by investors and traders simply because it generates income. Furthermore, there is a high probability of a small gain with a stock that has hardly any volatility. Investors see the maximum amount of gain when the total net premium is received. When there is a maximum possible loss, the stock has typically moved more than the long call strike or under the long put strike. 

Some Considerations About Strategies

You can open a demat account and invest in equity by the simple purchase and sale transactions with stock. However, employing strategies in the options segment gives you a real edge over your trades and makes trading exciting. Here are some important takeaways to consider before you strategise in options trading: 

  • Options investing may appear complicated at the outset, but there is a basket of strategies that several traders and investors proficiently use to traverse options investment. Most of these techniques can enhance returns by placing calculative bets on the movement of the markets. They even provide hedges in positions that already exist.
  • You should note that collars, married puts and covered calls are made use of while you already hold an existing position. 
  • Be aware that spreads constitute the buying of one or more options, and the sale of one option (or more than one). 
  • In the share market today, strangles and long straddles make profits when markets shift in an upward or downward direction. 

The Sideways Market

Any market in which prices don’t shift much over certain time spans is called a sideways market. Such markets are examples of low volatility environments where trading is concerned. In these types of markets, certain strategies can work more than others. These markets adhere to strategies of long butterflies, short strangles and short straddles. In these circumstances, premiums which are received from options writing are maximised when the options expire without any worth. 

More Strategies to Use

If you have already taken the effort to open a demat account and invest in the stock markets, it may be about time for you to indulge in options trading. This gives traders the appeal of winning good profits by employing strategies and techniques that are time-tested. Also with a host of underlying assets to trade in, you can diversify your portfolio with options investing. Granted, you may have subscribed to an upcoming IPO, but there's no harm in trying strategies that may get you quicker profits. 

In the area of options trading, there are more than ten strategies you can employ, and if you are seriously considering using strategies to implement good trades, you can use the calendar spread, for instance. This is usually made use of to bet on any changes in the volatility of the underlying asset. You can also use box spreads, and if you go into a little more depth with this strategy, you will discover that traders use it to lend or borrow funds to manage capital while trading in options. No matter what learning style you may have, and the kind of trader you are, strategies can help you in the course of trading. Its worth your while as a trader to study a little about trading per se, before you actively attempt a strategy. Traders have been using strategies in options trading for years, so you can too. 

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