There are a plethora of pre-built strategies on an options trading platform that can help you trade better. However, do these strategies only sound good on paper, or do they actually work? In this blog, let’s look at some of the most popular options trading strategies and discover how effective they are!
Trading Strategies and Their Effectiveness
No matter what options trading platform you choose, executing these dynamic trading strategies will help you capitalize on the underlying asset such as stocks, commodities, currencies, etc. Let’s dive in to know the 10 effective strategies that will help you deal with the highly volatile market.
1. Iron Condor
Iron Condor can be a useful strategy if you are trading in an underlying asset with very low volatility. The biggest advantage of this strategy is that you can attain high profits from little price movements.
This strategy is quite effective when the closing prices are between the middle strike prices at expiration and is suitable for varying starting capital. In fact, Iron Condor is preferred when selling premiums.
2. Bull Call Spread
Bull Call Spread is one of the most commonly used trading strategies when trading options on an options trading app. This strategy works wonders when there is a forecast that the market value of the asset will increase in value. Additionally, this strategy is quite effective when there is high volatility in the market.
When traders use this strategy, their gains and losses are limited by the lower and upper strike prices ( the price at which you can buy or sell the options before contract expiration). However, you need to remember that when you use the bull call spread strategy, your profit potential is quite limited.
3. Bear Put Spread
When you use the bear put spread strategy, you try to minimize the net risk of your trade. This strategy is effective in markets where the underlying asset prices are declining steadily.
The net amount you paid for the options is the difference between the premium received by selling the call and the premium at which the investor buys the call. Your profit is capped to the difference in the strike prices.
You may experience a great deal of risk if the prices of an asset rise rapidly. Therefore, this strategy is limited to slow and bearish markets!
4. Short Straddle and Long Straddle
Short and long straddles are also two of the most popular strategies you will find on your options trading platform! For this strategy to work, it must meet at least one of the three criteria listed below.
- Sideways market patterns
- Pending news, announcements, or earnings
- Extensive predictions from analysts on a certain announcement.
The analysts in this scenario have an enormous impact on how the market behaves. The market either moves in the direction they predicted or shows signs of fatigue.
One major challenge is whether to use a short or a long straddle. Well, for that, you need to carefully evaluate whether the market is moving counter to the predictions or if it is adding momentum to the direction of the news. If you fail to gauge this, this strategy will fail spectacularly.
5. Long Call Butterfly Spread
When the trader expects the stock price to exceed the strike price by expiration, this strategy is one of the best ones to execute. Primarily, this strategy is a combination of the bear spread and bull spread strategy. When the traders buy a call ‘Going Long,’ they use 3 different strike prices.
This strategy is either implemented by selling ‘at-the-money’ call options or buying one out-of-the-money call option.
6. Long Put Butterfly Spread
It is a 3 part strategy created by buying one put at a higher strike price and selling 2 puts at a lower strike price. This strategy creates a bearish bias when you buy another put with a lower strike price than the previous ones. However, centering a put above the strike price forms a bullish bias. Thus, be mindful of the same.
7. Long Call and Put
A trader buys a Long Call to benefit from the price appreciation of an underlying asset. It gives you the right to call or buy assets for a current price at a later date.
Want to know the best bet? The stock can never go below 0, capping the downside; simultaneously, the long call has immense potential to surge.
On the other hand, a long put is bought by a trader when there is an anticipation that the asset price will decline in the Long Put strategy. Primarily, this strategy can help traders generate profits when they expect the stock price will go less than the strike price by expiration.
However, if the price of an asset falls immensely, it signifies that it has a potential benefit till the price reaches 0. The upside of the long call and long put has equal potential to gain and can be the multiples of the options premium paid.
8. Married Call
Married Call is the reversal of the Married Put strategy. For a Married Call, a trader shorts shares of the underlying stock and simultaneously buys an equal number of call options to cover the short position.
Executing a Married Call proves to be a bullish strategy when the trader is concerned about the near-term uncertainties in an asset’s price.
9. Married Put
Married Put is one strategy similar to the Long Put, but with a twist. The trader buys a put alongside owning the underlying asset.
This strategy proves ideal when traders want to minimize their risk of holding an asset whether it is a stock, commodity, or bond. It is one of the best ways to ensure traders protect their downside risk and acts like an insurance policy by establishing a price floor in case the asset’s price unexpectedly declines.
The Strip is a bearish market-neutral strategy that involves placing 2 At The Money Puts and 1 At The Money Call. It turns out to be a lucrative strategy when an underlying asset crashes more than it surges. Yes, it is when traders can make a robust move in the down direction at the time of expiration.
However, these options must be purchased on the same underlying, with the same expiry date and strike price.
How to Minimize Risk When Using Options Strategies?
Traders can reduce their risk and increase their overall returns by using all these option strategies mentioned above. However, it is imperative to understand the risks associated with options trading and the means to reduce them.
Like other financial instruments such as bonds, stocks, and mutual funds, options trading also comes with a set of risks. You may end up losing the entire premium paid if your trade goes in the wrong direction.
So, how do you reduce the higher initial margin risk when you are dealing with options?
The best way to minimize it is through hedging strategies that significantly boost value when the investments you are investing in go in the opposite direction. Hedging the position reduces marginal requirements and one-sided unlimited risk to execute the trade seamlessly.
How to Find Arbitrage Opportunities in These Strategies?
Listed below are some of the most compelling ways that will help you as a trader to find arbitrage opportunities for options trading:
1. Long Stock Payoff Diagram
Analyzing long stock payoff diagrams will enable you to determine whether an option or set of options with other securities is worth it at option expiration. These diagrams facilitate traders speculating the value of the underlying stock price.
2. Synthetic Short Stock Payoff Diagram
This stock position comprises a Long Put paired with a short call struck at the same price and date. Holding a synthetic short stock position carries a delta of -1 per share or a net -100 delta.
3. Forward Conversion Payoff Diagram
Any change in the value of an underlying stock may cancel out because the trade ends up in the net gamma and delta of 0.
So, how do you reap profits from forward conversions? The first way to maximize your gains is by keeping dividends issued while holding the stock. The other and the most dynamic way to boost your profits is from the difference in the entry debit or credit for options trading following its strike price.
There are platforms providing you with multiple ways to discover arbitrage opportunities by using the filter or option search. However, this idea only works when you already own stock and have expiration in mind. You can also use screeners to filter and sort arbitrage opportunities of optionable stocks.
Suggested Books for the Best Option Trading Strategies
This list of books will help you in understanding options trading strategies and implement the same.
- Trading Options Greeks: How Time, Volatility, and Other Pricing Factors Drive Profit by Dan Passarelli: An informative guide for aspiring and advanced traders that tells them how to use trading strategies to reap profits even in a highly volatile market.
- Option Volatility and Pricing Strategies by Sheldon Natenberg: The book presents unvarnished insights into the advanced trading theories helping an investor to raise their net worth.
- Trading Options For Dummies By Joe Duarte: Joe Duarte explains how an investor or trader can beat today’s competitive and highly volatile market by remaining updated with new facts, charts, and strategies.
- Options as a Strategic Investment By Lawrence G. MacMillan: The book is well known for providing deep insights into stock and index options strategies.
Many popular trading strategies on an options trading platform seem quite effective when you put them into practice. So, execute them while trading options and see the difference. Do let us know which trading strategy changed your fortune!