Options are the kind of derivative contract that offers contract buyers the rights to purchase or sell a security at a particular price at a certain point in future. An amount known as a premium is charged to option buyers by the sellers for such rights. When market prices are unfavorable for the option holders, they let the options expire valueless (by not exercising the right) to ensure that the losses aren’t higher than the premium. Similarly, as the market goes in the direction that increases the value of this right, it is successfully used. Here are the two most common strategies used for options trading.
As per Tesler Trading, for the ones trying to make directional bets in the market, trading options has several advantages. When you think that asset prices are going to increase, you can purchase call options using less capital compared to the asset. In the same way, when the price falls, the losses remain limited to the amount paid for options, and nothing more. It can be a good strategy for the traders who:
- Want to make the best use of rising prices
- Are confident or ‘bullish’ about a certain stock, index fund, or ETF (exchange-traded fund) and want to mitigate risk
Essentially, options are leveraged instruments in the sense that they let the traders improve the possible upside benefits of using a smaller amount than what is usually needed while trading that underlying asset. Thus, rather than spending $10,000 to purchase 100 shares of a $100 stock, hypothetically you can spend about $3,000 on the call contract having a strike price ten percent higher than the present market price.
There is unlimited potential profit as the options payoff is going to rise with the underlying price until its expiry. As such, there is no theoretical limit to the height it can reach.
When the call option offers the holder the right to buy the underlying asset at a particular price before the expiry of the contract, a put option offers the holder the rights to sell the underlying at a fixed price. It is the preferred strategy for the ones who:
- Plans to use leverage to make the most of falling prices
- Feel bearish on a certain index, ETF, or stock, but plan to take less risk than using short-selling strategies
The put option effectively works exactly in the opposite direction from a call option, with the former increasing in value as the prices of the underlying goes down. Also, although short-selling lets a trader profit from the falling prices, the short position comes with unlimited risk as theoretically, there is no limit to how high the prices can go. When it comes to a put option, as the underlying goes higher than the strike prices of the option, the option is simply going to expire worthless.
When you do it right, options trading can be more valuable than you think. So, start researching and begin trading right away.