Option trading is a relatively new idea compared to other forms of trading, but it has been around long enough that some option trading strategies have started to emerge as being generally effective. Unfortunately, because options appear so promising and versatile, it is all too common for option traders to dive into the game with little understanding of the risks or benefits of option trading.
If a trader took just a short time to learn about the flexibility of options trading, and how to use this vehicle to full effect, they would be protected from a lot of the risk, and would be in a better position to make a profit.
There are a lot of popular trading strategies but the most basic strategy is to purchase options on popular equities, exercise the option if the equity gains value and then, sell immediately. This is a low risk strategy (the maximum you could lose is the cost of the option and commission). However, there are other more complex strategies. One popular strategy is called the iron butterfly.
The idea behind this strategy is that the investor combines a purchase or sale of a strangle with a long or a short straddle. This uses both calls and puts. This strategy limits the amount of loss that you can make but, unfortunately, it also limits profits, too.
On the surface, the idea of limiting profits may not seem too appealing, but the limit on losses is important to remember here. Note that with options trading it is possible to sell an option on an equity that you do not own – the potential losses there could be massive. Some high-risk investors use that option extensively, but it is not something that an untrained investor should ever enter into lightly.
The Bull Call Spread is a great option for investors. This involves buying call options at one price, and then sell options at a higher price. The call options have the same asset and the same expiration, and are useful if someone expects to see a moderate increase in the value of an asset, but wants protection against losses.
The long straddle involves buying a call and a put at the same price, with the same asset and the same expiration date. this is a good option if someone is convinced that an asset is going to move a long way, but they’re not sure in which direction.
The iron condor is an interesting option, in which someone holds both a long and a short option in two different strategies. This can be a complex strategy and it must be worked out carefully to ensure that you come out on top no matter which option you take – failure to calculate fees properly could make this option backfire significantly.
There are many other option trading strategies out there. It takes patience and practice to find the one that works best for you, but the good news is there are demo accounts that you can practice with while not putting your own money at risk.