A beginner’s guide to options strategies

Call options and put options are the two main options strategies. Below is a brief overview of how to profit from using these options in your portfolio.

Key points

  • For beginners, there are several basic option strategies that can provide relatively simple structures and direct profit and loss results.
  • Buying options can be used to avoid risks, or to speculate without taking too much downside risk.
  • Written guaranteed options can provide additional income with limited risk.
  • More complex combinations and spread strategies can also be used, but a deeper understanding of option trading may be required.

Put and call options

Call options provide investors with the right to buy stocks at a specific price, but without obligations. This price is called the strike price or strike price. Put options provide investors with the right to sell stocks at a specific price, but without obligations. This price is also called the strike price or strike price. Other important contract terms include the size of the contract. For stocks, each contract usually has a denomination of 100 shares. The expiration date specifies when the option expires or expires. The style of the contract is also very important, and it can take two forms. American options allow investors to exercise options at any time before the expiry date. European options can only be exercised on the expiry date.

Write call options for income

Buying call options is the same as going long or profiting from rising stock prices. Like stocks, investors can also short or sell call options to obtain a premium. If the stock price is higher than the exercise price, the call option seller is obliged to sell the stock to the call option holder.

When writing call options, short investors bet that the stock price will remain below the strike price during the validity period of the option. As long as this happens, investors will earn income and premiums from the strategy.

Three ways to profit using call options

Combine one call with another option

To create more advanced strategies and demonstrate the use of call options in practice, consider combining call options with write-out options. This strategy is called a bull market call spread, which involves buying or long call options and combining it with a short strategy that sells the same number of call options at a higher strike price. In this case, the goal is to profit from a narrow trading range.

For example, suppose that a stock is traded at $10, call options are purchased at a strike price of $15, and call options are sold at $20 at a premium of $0.04 per contract. This assumes a single contract with a premium income of US$4 or US$0.04 x 100 shares. Regardless of the situation, investors will retain premium income. If the stock stays between $15 and $20, the investor will retain the premium income and profit from the long bullish position. Below $15, long call options are worthless. Above US$20, the investor maintains a premium income of US$4 and a profit of US$5 in long call options, but loses any upside above US$20, because a short position means the stock will be called back.

Write put options for income

Buying put options is similar to shorting stocks or profiting from falling stock prices. However, investors can also go short or write a put option, hoping that the stock will remain above the strike price to obtain an option premium. If the stock falls below the strike price, the seller of the put option is obliged to buy the stock from the holder of the put option (because it is actually “put” to the seller). Similarly, this happens if the stock price is lower than the strike price.

When selling a put option, short investors bet that the stock price will remain above the strike price during the validity period of the option. As long as this happens, investors will earn income and premiums from the strategy.

Combine a put option with another option

To create more advanced strategies and demonstrate the use of put options in practice, consider combining put options with call options. This strategy is called a straddle combination and includes buying put options and long call options. In this case, investors speculate that the stock will have a relatively significant upward or downward trend.

For example, suppose that the trading price of a stock is $11. Straddle strategies can be relatively simple, including the purchase of put and call options at a strike price of $11. Buy two long options with the same expiration date, and if the stock rises or falls by more than the cost of buying these two options, you will make a profit.

Assume that the most recent transaction price of XYZ’s stock is $11 per share. The cost of the call option is US$0.20, the cost of the put option is US$0.15, and the total cost is US$0.35. In this case, the stock must rise above $11.35 to obtain the return of the call option, and below $10.65 to obtain the return of the put option.

Bottom line

These simple call and put option strategies can be combined with a large number of more exotic positions to generate profits and control risk.

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