Options Trading Strategies for Beginners: From Basics to Tips for Success – Part 3

Options trading is a form of investment that can be profitable for experienced and novice traders. It involves the purchase and sale of options contracts, agreements between a buyer and a seller to buy or sell a specific asset at a predetermined price on or before a specified date. Options trading provides more flexibility than traditional stock trading, as traders can buy and sell contracts at any time and use different strategies to increase their returns. Part 3 will focus on implementing three more options trading strategies: covered put, bull call spread, and bear put spread.

4. Covered Put

This strategy involves selling a put option on an asset the trader does not own. The trader collects a premium for selling the put option, which gives the buyer the right to sell the asset at the strike price. The trader keeps the premium if the asset’s price exceeds the strike price. If the asset price falls below the strike price, the buyer will exercise their option, and the trader will have to buy the asset at the strike price. This strategy can generate income for traders, but the profit potential is limited.

Example of a successful implementation of this strategy:

A trader who owns 100 shares of Amazon Inc. (AMZN) stock sells a put option with a strike price of $2,800 and a premium of $10 per share. If the stock price remains above the strike price, the trader keeps the premium, representing a 3.3 percent return on investment. If the stock price falls below the strike price, the trader is obligated to buy 100 shares of the stock at the strike price, but the trader already owns 100 shares of the stock, which can be used to fulfill the obligation. The strategy allows the trader to generate additional income while protecting against downside risk, with the risk limited to the cost basis of the stock.

5. Bull Call Spread

This strategy involves buying a call option with a lower strike price and selling a call option with a higher strike price. The trader pays a premium for the lower strike price call option and collects a premium for the higher strike price call option. If the asset price rises above the higher strike price, the trader can exercise the lower strike price call option and make a profit. The risk in this strategy is limited to the difference between the premium paid and the premium collected.

Example of a successful implementation of this strategy:

A trader who was bullish on Apple Inc. (AAPL) bought a call option with a strike price of $320 and a premium of $10 per share. AAPL stock increased in price, and the trader exercised the call option to buy 100 shares of AAPL stock at the strike price of $320 per share. The trader then sold 100 shares of AAPL stock at the market price of $350 per share, realizing a profit of $2,000 or a return on investment of 200 percent. The risk in this strategy was limited to the premium paid for the call option.

6. Bear Put Spread

This strategy involves buying a put option with a higher strike price and selling a put option with a lower strike price. The trader pays a premium for the higher strike price put option and collects a premium for the lower strike price put option. If the asset price falls below the lower strike price, the trader can exercise the higher strike price put option and make a profit. The risk in this strategy is limited to the difference between the premium paid and the premium collected.

Example of a successful implementation of this strategy:

A trader who is bearish on Tesla Inc. (TSLA) buys a put option with a strike price of $750 and a premium of $15 per share. The trader gains the right, but not the obligation, to sell 100 shares of TSLA stock at the strike price of $750 per share until the expiration date of the option. If the price of TSLA stock falls below the strike price, the trader can exercise the put option and sell 100 shares at the higher strike price. If the price of TSLA stock remains above the strike price, the option will expire out of the money, and the trader will lose the premium paid for the option. The strategy allows the trader to profit from a potential price decline in TSLA stock while limiting risk, with the risk limited to the premium paid for the put option.

Conclusion

Options trading strategies for beginners can be a great way to begin investing in the stock market. Although each strategy has its own risks and rewards, a comprehensive understanding of the fundamentals and how to employ each strategy in the right context is essential for successful trading. With the right knowledge and experience, any beginner can successfully navigate the options trading world.

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