Tag Archive | "Options Trading Strategies"

Option Tips and Strategies For Trading Options


Option Tips – Where to Learn About Trading Options

Option TipsThe most important of all option tips is that before even considering trading options, take the time to learn about options trading and options trading strategies.  A preliminary options trading education and introduction to option tips can be found in the following articles:  Option Trading Basics, Trading Call Options, and Managing Options Trading Risk.

Investopedia.com provides a good introduction to options trading and option tips in an entry called Options Basics:  Introduction.  More detailed options trading information and option tips are available at Optiontradingpedia.com.  These are just two of many sites on the Internet that provide options trading information and option tips.  It is highly recommended that an investor that is new to options trading gain a firm understanding of the risks and rewards associated with options trading prior to commencing with options trading.

Option Tips and Strategies for Trading Options

One of the most important option tips is to understand that options have a number of different uses in the stock and commodities markets, and therefore, options trading strategies vary depending upon why options are purchased.  Certain options trading strategies do not apply to every options trade.

Call options are purchased when one anticipates that a stock or commodity will make a move higher before the option expires.  Put options are purchased when one anticipates that a stock or commodity will make a move lower before the option expires.  Buying put and call options can be used as a pure trading strategy to try to make money from an anticipated price move or as a hedging trading strategy to protect an existing position held in a stock or commodity.

The most common of all option tips is to buy Call options for a stock or commodity you expect to move higher rather than the stock or commodity itself.  Call options allow traders to reduce the amount of capital needed for a trade and to protect against an unanticipated drop in price of a stock or commodity.  The advantage of playing a stock or commodity on the long side via Call options is that the downside risk can be quantified as the price paid for the option.  Also, not as much money has to be committed to the trade since Call options cost just a fraction of the price of a given stock or commodity.

Another one of the common option tips is to buy Put options to protect the downside risk of a stock or commodity one is holding long, but does not want to sell.  A Put option gives one the right to sell the amount of shares or commodity covered by the option (typically a block of 100 shares for each option) at the specified option strike price prior to the option expiration date.  If one has a gain in a stock or commodity and want to ensure that no matter what happens to the price of the stock or commodity due to unforeseen events, one can get out with a profit, Put options are a good way to protect that gain.

One of the commonly overlooked option tips is to use limit orders to buy and sell options.  Use of limit orders when buying and selling Call and Put options can save money, especially if one is an active options trader.

A summary of option tips would not be complete without the standard warning that all options traders must understand about the difference between stocks and options.  Unlike stocks, options suffer from price decay as they approach their expiration date, which means they methodically lose value over time.  Once the expiration date is reach, an option will expire worthless, unless the strike price of the option has been exceeded to either the upside or downside, depending upon if it is a Call or Put option.

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Managing Options Trading Risk


The Basics of Managing Options Trading Risk

Managing Options Trading RiskManaging Options Trading Risk is very important because trading options carries the risk of losing all of the trading capital committed to trading options, since options can expire worthless if their strike price is not achieved prior to the option expiration date.  To mitigate this risk of total trading capital loss, there are a number of options trading strategies that can employed for managing options trading risk.

What really makes options interesting and useful from a risk management prospective is that unlike stocks, managing options trading risk can be absolutely defined when an options trader executes a well designed risk management options trade.  In other words, a well designed risk management options trade will limit an options trader’s risk of capital loss to a fixed amount that the trader can calculate.  This is done by buying and selling various types of options to cancel out the potential for an option to expire worthless upon expiration.  Such a strategy limits profit potential when trading options, but the trade off is well worth it to options traders looking to protect trading capital in the event that the options that they hold do not hit their strike price upon expiration.

Strategies for Managing Options Trading Risk

Managing options trading risk involves the execution of a number of different well designed risk management options trades.  The type of options trade utilized to manage risk in a particular situation depends upon the objective of the options trade, current market circumstances, and the anticipated move that an options trader expects from the underlying stock or commodity on which an option is based upon.  The following is a list of options trading strategies for managing options trading risk.

  • Option Straddle An option straddle involves buying a call option and put option at a stock or commodity’s current trading price with same strike price and month for both options.  A profit can be made on an option straddle if the stock or commodity moves above or below the strike price enough to cover the premium paid for the put and call options.  There is a risk of losing the premium paid for the options, if the stock or commodity does not move away from the options strike price before expiration; therefore, an option straddle should be used during times of market volatility and uncertainty.
  • Option Strangle An option strangle involves buying the same quantity of a call option and a put option for the same stock or commodity, but at different strike prices that are away from a stock or commodity’s current trading price, which are known as “out of the money” options.  While a premium is paid to create an option strangle trade, that premium is protected by the opposing option positions, as either the call or put option will gain in value as the stock or commodity moves up or down in price.  A strangle option trade is usually less expensive than a straddle option trade since “out of the money” option contracts are less expensive than option contracts that are at the current trading price of the underlying financial instrument.
  • Option Ratio Spread – An option ratio spread involves buying a quantity of call or put options and selling a quantity call or put options for the same stock or commodity and the same expiration date, but at different strike prices.  If an options trader is expecting a stock or commodity to increase in price, they would initiate an option ratio spread trade by buying a greater number of call options at or near the current trading price and then selling a lesser number of put options at a higher strike price.  An options trader would do the opposite if they are expecting a stock or commodity to decrease in price.  The premium paid for an option ratio spread is reduced by selling puts when initiating a long option ratio spread and selling calls when initiating a short option ratio spread.  The premium paid for an option ratio spread is protected by the opposing option positions.

Those who wish to trade options are encouraged to learn as much as possible about managing options trading risk and the various ways options can be traded.

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