They are among the sought-after trading instruments, as they are able to move quickly and make (or losing) lots of money quickly. Options strategies be quite straightforward to highly complex, and come with many outcomes and sometimes bizarre names. ( option trading alert services , anyone?)
No matter how complex regardless of their complexity, all options strategies are based on two fundamental kinds of options: the call and put. Below are five of the most popular options and an overview of their rewards and risk , and the times they could be leveraged by a trader to fund the next time they invest. Although these strategies are simple, they can earn an investor quite a bit of money.
1. Long-distance call
In this method, the trader purchases a call which is referred to by the term “going long” with a call and hopes for the price to be higher than the strike price before the time of expiration. The potential upside of this strategy is unlimited and traders could get many times the amount of their initial investment, if the price rises.
Example: Stock X is trading at $20 per share. Similarly, an option with a strike value of $20, and expiration date of four months is traded at $1. The contract will cost $100, which is 1 contract * $1 = 100 shares of shares for each contract.
Risk/reward: In this example the trader is able to break even at $21 for each share which is the strike value, plus the premium of $1. If the price is above 20 dollars, an option grows worth $100 per each dollar that the stock goes up. The option expires void when the stock price is at the price of the strike and is below.
The upside for the long call is theoretically endless. If the price of the stock increases before expiration, the call could increase in value and vice versa. Because of this, long-term calls are among the most sought-after ways to bet on the price of a stock rising.
The negative of a lengthy call is the total loss of your investment. This is $100 in this instance. If the stock closes lower than the price of strike then the call expires meaningless and you’ll walk away with nothing.
When should you make use of the option: The long-call option is a great option when you anticipate that the stock will increase significantly prior to the option’s expiration. If the price rises just one percent over the strike price the option could be still within the range of being profitable, yet it may not return the amount paid which leaves you with a loss.
2. Calls that are covered
A covered call is the act of selling the option of a call (“going short”) however with an added twist. The trader is selling the option but also purchases the stock that is the basis of the option, which is 100 shares for every call sold. The stock’s ownership turns an investment that could be riskythe short callis a relatively secure option that generates earnings. Stock prices are expected to be lower than the strike price when it expires. If the price is higher than that price at expiration, then seller must offer the shares to a buyer on the call for the price of strike.
Examples: Stock X is trading at $20 per share. Similarly, an option that has a strike price of $20 and expiration within four months is priced at $1. The contract will pay the buyer $100 in premium, which is equivalent to one call * 100 shares by each contract. The trader purchases 100 shares at $2,000 and then sells one call for $100.
Risk/reward: In this case the trader makes through at $19 for each share which is the strike value less the $1 premium that was paid. If the price is less than $15, the trader will lose money since the stock will lose money, greater than equal to any $1 price. At a price of 20 dollars, the investor could keep the full amount of the premium and hold on to the stock as well. Beyond $20, the profit is limited to $100. The short call is liable to lose $100 for each dollar increase over $20, this is completely compensated by the gain of the stock which leaves the trader with the $100 initial premium that is redeemed as the profit total.
The benefit of the covered call is limited to the price that is paid, regardless of how much the price of the stock goes. There is no way to make additional than that however you may lose more. Any gain you would have realized with the rise in the stock price is neutralized through the shorter call.
The risk is a complete loss of your stock investment in the event that the stock falls to zero, minus the amount of premium you pay. The covered call can lead to a substantial loss in the event that the stock drops. In our scenario, if the price dropped to zero, the loss would be $1,900.
When to utilize this method: A covered call is a great method to earn income if you already have the stock but don’t anticipate that the price will rise dramatically soon. The strategy can turn your current assets into cash. Covered calls are popular among people who have a need for income and can be beneficial in retirement accounts in which you would be taxed on the cost of the call and capital gains when the stock is traded.
3. Long put
In this method it is the case that the trader purchases the put — often known by the term “going long” or a put and anticipates the price of the stock to be lower than the strike price at expiration. The benefits of this investment could be multiples of the initial investment, if the stock drops significantly.
Examples: Stock X is trading at $20 per share. Similarly, put options that has a strike price of $20 and expiration within four months trades at $1. The contract is $100, which is the cost of one deal * $1 = 100 shares of shares for each contract.
Reward/risk In this case the put is at break-even when the stock trades on the date of expiration of the option for $19 each share which is the strike value less the $1 premium that was paid. Under $19, the put grows in value by $100 for each dollar decrease in the price. Beyond 20 dollars, the puts is without value, and the trader forfeits the entire value of $100.
The upside of a long put is as great as a long call as the gains could be multiples of premium for the option. But, a stock could never be below zero, limiting the potential upside, while a long call can theoretically have unlimited upside. Long puts are a simple and well-known method of betting on the price decline of an investment.
The negative of a put is limited to the amount of premium you pay, which is $100 here. If the price of the stock is higher than the strike price by the time of expiration of the put, it expires in vain and you’ll lose the money you invested.
When should you make use of this optionA Long put can be the best option when you anticipate that the stock will decline significantly prior to the time when the expiration date. If the price falls just a little below the price at which the option is struck, it is still in the money, however it could not pay back the premium that you paid, leaving you with an unintentional loss.
4. Short put
This is the opposite to the longer put however, the trader here sells put — often called “going short” the term used to describe a put and anticipates the price of the stock to be higher than the strike price at expiration. In exchange in exchange for selling a put the buyer receives a cash premium that is the highest amount that a put with a shorter term can earn. If the stock is trading lower than the strike value upon expiration time the trader is required to buy it at the price of the strike.
Examples: Stock X is trading at $20 per share. In addition, the put with a strike value of $20, and expiration within four months, is traded at $1. The contract will pay the buyer $100 in premium, which is one (1) $1 = 100 shares each contract.
Reward/Risk:In this example, the short put is at break-even at $19 which is the price at the time of the put, less amount that was paid. Under $19, the short put is priced at $100 for each dollar that declines in price. Above $20, the seller gets the entire $100 price. From $19-$20, the seller of the put could earn a small amount but not all the price.
The benefit of the short put is not greater than the amount of premium paid which is $100 here. As with the short call and covered calls, the highest profit on the short put is what the seller earns in the beginning.
The disadvantage of short puts is the value of the stock being traded the premium that was paid. it would occur if stock dropped to zero. In this case the trader would need to buy $2,000 of stock (100 shares ($20 strike price) However, this will be reduced by the premium of $100 paid, resulting in the loss to be $1,900.
When should you utilize this strategy: A short put is a suitable strategy when you are expecting the stock to trade in the same price as the strike, or higher when the option expires. The stock should be above or equal to the strike price to allow the option to run out of value which allows you to keep the entire premium you received.
The broker will ensure you have enough capital in your account to purchase the stock should it be offered on you. A lot of traders have sufficient cash to buy the stock should the put expires with cash. It is possible to close the options before expiration and then take the net loss, but without needing to purchase the stock in person.
5. Married put
This strategy is similar to the long put but with twist. The trader is the owner of the stock, and buys put. This is a hedged deal that is where the buyer believes that the stock will rise but also wants “insurance” for the eventuality that the price drops. If the stock does plummet the long put will offset the loss.
Examples: Stock X is trading at $20 per share. In addition, put options with a strike value of $20, and expiration date of four months trades at $1. The contract is $100, which is one contract * 100 shares by each contract. The buyer purchases 100 shares at $2,000 and then buys a put for $100.
Reward or risk: In this example the put that is married breaks even at the price of $21, or the strike price, plus the price of the premium. At a price below $20, the put will offset the loss in the stock by one dollar. Above $21, the overall profits increase by $100 for each dollar increase in the price but the put will expire in value and the trader is liable for all of the premium. Here, it’s $100.
The maximum upside of a put that is married is theoretically unlimited for as long as the stock is rising less costs associated with the put. The put that is married is a hedged investment and the cost represents the expense of protecting the investment, and providing it with the chance to grow with minimal risk.
The drawback of a put that is married is the cost of the premium. If an asset position declines the put will increase in value, which covers the decrease dollar-for-dollar. This hedge means that traders only lose any cost associated with the put, rather than the greater loss to the stock.
When to apply this option The married put can be a smart choice when you are expecting that a stock’s value to rise dramatically prior to the time of the option’s expiration however, you are concerned that there is a possibility to drop significantly, too. The married put permits you to keep the stock and benefit from the potential upside should it goes up, but be protected from a substantial loss in the event that the stock drops. A trader may be waiting for announcements, like earnings that could push the price up in value or decrease it, but needs to be protected.