Options Trading Strategies for Beginners
Author: James Clark
Understanding Options Trading Strategies
If you’re well-versed in the basics of stock trading, it’s time to dive into a more complicated part of it - Options Trading. Stock traders have many assets to build their portfolio, but trading options is one of the most misunderstood concepts in the trading world.
Read on to learn more!
What Is Options Trading and How Does it Work?
An option is a contract that permits traders to buy or sell an asset at a pre-established rate by a certain date. Options trading allows you to predict which direction the price of a stock might go. You don’t have to buy or sell an asset outright. Instead, you can:
Use a Call Option: Purchase a contract authorizing your right to buy a specified asset for a set price, known as the strike price, by a certain date.
Use a Put Option: Purchase a contract authorizing your right to sell a specified asset for a set price by a certain date.
If you’re not willing to perform an action, let the contract expire with no financial obligation.
Buyers have to pay a premium to purchase a contract. Let’s look at an example. Trader X acquires a call option for purchase Tesla shares at $500. If the share price falls, he could let the contract expire. However, if the share price rises too, let’s say $550, he could purchase the shares at $500 and sell them at market price later on. Now, you might think such a trading strategy might be useful for day traders or short-term traders only, but it is just as effective in the long run.
3 Options Trading Strategies for Beginners in 2021
Options trading strategies can help investors both minimize risk and maximize rewards if used correctly. Options trading provides the advantage of flexibility, which can help traders profit greatly. Here are some strategies every trader should know:
1. Covered Call
This options trading strategy comprises of two parts and depends on stock price dropping. First, the trader acquires a stock. Then, apply a sell contract on it and receive the premium. Once the price drops, traders hope for the buyer to abandon their contract. This way they get to keep both the premium and their stock.
2. Short Put
A short put is like a covered call but in reverse. First, trader A sells a put option to trader B, hoping for an increase in stock price. Once the stock price increases, trader B abandons the contract, thus enabling trader A to profit from the premium.
3. Long Straddle
This involves traders buying a call and put option together, with the same expiration date and strike price. It is a neutral strategy that aims to offset the loss of one contract from the profit of another.
The Bottom Line
Investing in the stock market comes with risk, but traders can always employ tools that help mitigate it. Options trading is one of the most useful tools that traders have to use to decrease their risk and increase their reward.
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