If you are new to option trading, you might be wondering what are some of the basic strategies that you can use to profit from this versatile financial instrument. Options are contracts that give the buyer the right, but not the obligation, to buy or sell an underlying asset at a specified price and time. Options can be used for various purposes, such as hedging, speculation, income generation, or portfolio diversification.
In this blog post, we will introduce some of the basic option trading strategies for beginners that can help you get started with this exciting and potentially lucrative market. We will assume that you have some familiarity with the basic concepts and terminology of options, such as calls, puts, strike price, expiration date, intrinsic value, extrinsic value, and implied volatility. If not, we recommend that you review these terms before proceeding.
Here are some of the basic option trading strategies for beginners:
- Long call: This is a bullish strategy that involves buying a call option on an asset that you expect to rise in price. You pay a premium to buy the option and your maximum loss is limited to the premium paid. Your potential profit is unlimited as the asset price rises above the strike price. The breakeven point is the strike price plus the premium paid.
- Long put: This is a bearish strategy that involves buying a put option on an asset that you expect to fall in price. You pay a premium to buy the option and your maximum loss is limited to the premium paid. Your potential profit is unlimited as the asset price falls below the strike price. The breakeven point is the strike price minus the premium paid.
- Short call: This is a bearish strategy that involves selling a call option on an asset that you expect to stay below the strike price. You receive a premium to sell the option and your maximum profit is limited to the premium received. Your potential loss is unlimited as the asset price rises above the strike price. The breakeven point is the strike price plus the premium received.
- Short put: This is a bullish strategy that involves selling a put option on an asset that you expect to stay above the strike price. You receive a premium to sell the option and your maximum profit is limited to the premium received. Your potential loss is unlimited as the asset price falls below the strike price. The breakeven point is the strike price minus the premium received.
- Covered call: This is a neutral to mildly bullish strategy that involves buying an asset and selling a call option on it. You receive a premium to sell the option and your maximum profit is limited to the premium received plus the difference between the asset price and the strike price. Your potential loss is limited to the difference between the asset price and the premium received minus any dividends paid by the asset. The breakeven point is the asset price minus the premium received.
- Protective put: This is a neutral to mildly bearish strategy that involves buying an asset and buying a put option on it. You pay a premium to buy the option and your maximum profit is unlimited as the asset price rises above the strike price. Your potential loss is limited to the difference between the asset price and the strike price plus the premium paid minus any dividends paid by the asset. The breakeven point is the asset price plus the premium paid.
