- Don’t sleep on these three useful options trading strategies…
- How non-directional bets and reducing time decay can expand your trading possibilities…
- Why these different strategies exist and how traders can weaponize them…
When trading common shares, you essentially have two choices — buy the shares long or short the shares. Trading stocks is kind of like going to a pizza shop that serves only cheese and pepperoni slices.
But options trading is more like an all-you-can-eat buffet. You aren’t limited to simply buying contracts. There are a variety of ways you can structure options trades to suit your current trading plan.
With that in mind, let’s look at three crucial options trading strategies every Evolver should know.
To trade a straddle, you simultaneously buy a put and a call at the same strike price. The strike chosen is usually at the money (or near the money).
Straddles serve as non-directional bets on volatility. If you think a stock’s primed for a big move, but you aren’t leaning bullish or bearish, straddles are an excellent strategy to consider.
For example, let’s say stock XYZ has an earnings call at the end of the week. It’s trading on high-volume pre-earnings, so you expect a big move post-earnings. That being said, you have no inkling whether the stock will go higher or lower…
By buying a straddle, you can profit off of a big move in either direction. This stands in contrast to “gambling on earnings” by buying either puts or calls by themselves. If you only take one side of the options chain, you only have a 50% chance of success.
If the probability of success is so much higher, why doesn’t everyone trade straddles?
In practice, straddles pay out less than a naked call or put. This is because the trade costs more as you need to buy both a put and a call. If you’re right, and the stock blasts higher or lower before your expiration date, one side of your trade will inevitably expire worthless.
You’re paying the extra premium for a higher probability of success (in either direction). This is why straddles are perfect for stocks approaching a coin toss earnings report (or any similarly volatile catalyst).
Strangles work exactly like straddles with one key difference…
Instead of buying a put and a call at the same strike price, you buy a put and a call at different strike prices.
Think of strangles as riskier, more specific straddles. You only want to use this strategy if you have a strong conviction in the stock moving a set amount in either direction.
But if they’re riskier than straddles, why trade strangles?
The answer is simple — the upside is bigger.
If one of the legs of your trading strategy pays out, the entire strangle will be considerably more profitable than a basic straddle.
As usual…the bigger the risk, the bigger the reward.
Debit spreads can be a way to make a leveraged options bet while simultaneously reducing exposure to time decay. Let me explain…
To open a debit spread, you first buy a call or a put. For this example, we’ll stick with calls. The strike for this call should either be at the money, or near the bottom of your target price range. This call is the “long leg” of your vertical spread.
As you buy this call, you simultaneously sell (or synthetically short) a further out-of-the-money call. This call is the “short leg” of the spread. You do this all in one trade.
This subtracts (or “debits”) the short leg’s premium from the long leg’s premium so it’s less expensive to enter the trade.
Here’s a hypothetical example — let’s say stock XYZ currently trades for $20. You think it could hit $30 by October 10, but probably not $40.
$30 calls for October 10 cost $3.50, while $40 calls cost $1.
If you buy one vertical spread — with these strikes being your long and short legs, respectively — your cost basis will look like this:
$3.50 – $1.00 = $2.50
This stands in contrast to buying the $30 calls naked, which would cost $3.50.
Reducing your cost gives you the invaluable opportunity benefit of extra capital to trade elsewhere. It also reduces your exposure to time decay.
This is because you’re short a far out of the money call while being long the contracts that are closer to the money.
On a red day for the stock, your spread will be down considerably less than a naked call, because the “short strike” of your vertical will actually be green.
So what’s the catch? Aside from laziness and lack of research, why would anyone buy a naked call?
If the stock goes beyond your short strike, the spread begins to lose value.
This hypothetical loss scares a lot of newbie traders away — but it shouldn’t.
All you have to do is monitor your trade closely and cut the spread as soon as you hit your target. If done correctly, you’ll spend less money to enter the trade and minimize your exposure to time decay.
- There are many strategies you can use when trading options. The choice is yours…
- These differing strategies exist because they’re designed to potentially profit off of very specific setups…
- It’s crucial to have a strong grasp of the different strategies available to you. If you don’t, you may be leaving money on the table…
Most options traders start by simply buying puts or calls…
But as you evolve into a more experienced trader, you should become familiar with any strategy that could be useful in your trading plan.
And there are many more strategies for us to cover in the future. We only scratched the surface today — the possibilities are endless.
Editor, Evolved Trader Daily
*All content in this newsletter is intended for educational and informational purposes only.
The material in this newsletter is not to be construed as (i) a recommendation to buy or sell stocks, (ii) investment advice, or (iii) a representation that the investments being discussed are suitable or appropriate for any person. No representation is being made that following Evolved Trader Daily strategies will guarantee a particular outcome or result in profits. The price and value of stocks may fluctuate depending upon various market factors, and, as such, the strategies used by Evolved Trader Daily to adjust for those fluctuations may change without notice.
There are significant risks associated with trading stocks and you must be aware of those risks, and willing to accept them, in order to invest in these markets. Past performance of any trading system or methodology is not indicative of future results. You should always conduct your own analysis before making investments.
You should not trade with money you cannot afford to lose and there is a risk that trading stocks will result in a complete loss of your investment. Trading stocks, particularly penny stocks, is not suitable for everyone and requires hard work, due diligence, capital, and substantial time to monitor the market and timely execute trades.