The expiration month reflects the time horizon of his market view. Let us consider the following scenario: Mr. X has purchased shares of ABC Ltd. Thus, the net outflow to Mr. X is Rs. The upside profit potential is limited to the premium received from the call option sold plus the difference between the stock purchase price and its strike price.
If the stock price stays at or below Rs. X can retain the premium of Rs. For the ease of understanding, concepts such as commission, dividend, margin, tax and other transaction charges have not been included in the above example. Any increase in volatility will have a neutral to negative impact as the option premium will increase, while a decrease in volatility will have a positive effect. Time decay will have a positive effect. The covered call strategy is best used when an investor wishes to generate income in addition to any dividends from shares of stocks he or she owns.
However, it may not be a very profitable strategy for an investor whose main interest is to gain substantial profit and who wants to protect downside risk. The Call Backspread is reverse of call ratio spread. It is bullish strategy that involves selling options at lower strikes and buying higher number of options at higher strikes of the same underlying stock. It is unlimited profit and limited risk strategy.
All About Options Strategy
The Call Backspread is used when an option trader thinks that the underlying asset will experience significant upside movement in the near term. A believes that price will rise significantly above Rs on or before expiry, then he initiates Call Backspread by selling one lot of call strike price at Rs. Maximum profit from the above example would be unlimited if underlying assets break upper breakeven point.
However, maximum loss would be limited to Rs. Delta: If the net premium is received from the Call Backspread, then the Delta would be negative, which means even if the underlying assets falls below lower BEP, profit will be the net premium received. If the net premium is paid then the Delta would be positive which means any upside movement will result into profit. Vega: The Call Backspread has a positive Vega, which means an increase in implied volatility will have a positive impact. Theta: With the passage of time, Theta will have a negative impact on the strategy because option premium will erode as the expiration dates draws nearer.
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Gamma: The Call Backspread has a long Gamma position, which means any major upside movement will benefit this strategy. The Call Backspread is best to use when an investor is extremely bullish because investor will make maximum profit only when stock price expires above higher bought strike.
As the name suggests, the Stock Repair strategy is an alternative strategy to recover from loss that a stock has suffered due to fall in price. The Stock Repair strategy helps in recovering losses with just a moderate rise in the price of the underlying stock. Stock Repair strategy is initiated to recover from the losses and exit from loss making position at breakeven of the underlying stock. A Stock Repair strategy should be implemented by investors who are looking forward to average their position by buying additional stocks in cash when the underlying stock price is falling.
Instead of buying additional stock in cash one can apply stock repair strategy. Stock Repair strategy is implemented by buying one At-the-Money ATM call option and simultaneously selling two Out-the-Money OTM call options strikes, which should be closest to the initial buying price of the same underlying stock with the same expiry.
For example, an investor Mr. A thinks that price will rise from this level so rather than doubling the quantity at current price, here he can initiate the Stock Repair strategy. This can be initiated by buying one May 90 call for Rs. The net debit paid to enter this spread is Rs. Had Mr A doubled his position at 90 level then he would have lost Rs. This shows he is much better off by applying this strategy. May 90 call bought would result in to profit of Rs. Net gain would be Rs. Followings are the two scenarios assuming Mr A has implemented the Stock Repair strategy whereas Mr B has doubled his position at lower level.
The Stock Repair strategy is suitable for an investor who is holding a losing stock and wants to reduce breakeven at very little or no cost. This strategy helps in minimizing the loss at very low cost as compared to "Doubling Down" of position. The Call Ratio Spread is a premium neutral strategy that involves buying options at lower strikes and selling higher number of options at higher strikes of the same underlying stock.
The Call Ratio Spread is used when an option trader thinks that the underlying asset will rise moderately in the near term only up to the sold strikes. This strategy is basically used to reduce the upfront costs of premium paid and in some cases upfront credit can also be received. A believes that price will rise to Rs.
For this strategy to succeed the underlying asset has to expire at In this case short call option strikes will expire worthless and strike will have some intrinsic value in it.
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However, maximum loss would be unlimited if it breaches breakeven point on upside. Delta: If the net premium is received from the Call Ratio Spread, then the Delta would be negative, which means slight upside movement will result into loss and downside movement will result into profit. Another advantage: If the contract itself becomes profitable, you can sell it without buying the shares.
Note: A trader would buy a lot of time value here for LEAPs due to the extended expiration dates compared to watching the asset market to either time their entry into the asset or purchase a shorter-term option. Although the downside is limited, that long time frame does present a risk to the initial outlay of funds for premium. The major advantage of buying LEAPS is that your maximum loss is limited to the amount of premium you pay. This strategy works well with NASDAQ and Russell growth stocks that offer no dividend and would otherwise scare away risk-averse traders because of their wild price swings.
Risk neutral strategies take the stance of not knowing whether a stock will rise or fall. The profit in this class of strategies comes from changes in the underlying asset, especially at expiration. If a stock was trading in a wide range and calms down, or vice versa, options can gain or lose value with no net gain or loss in the stock price. You take in a net credit with this strategy that is also your maximum profit potential.
Ideally, you want the price of the stock to stay between the short call and put strikes. All 4 options expire out of the money and are worthless, and you keep the upfront premium. When the market experiences a pullback or moves into a bear market, the movement is many times sudden and drastic.
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This is why many expert traders make a living playing the short side of the market. They deal with relatively low win rates on their strategy but the wins are usually quite significant. Buying puts allows you to profit when a stock falls in price. This strategy seems simple because it is.
The sophistication comes in the patience required to properly anticipate a fall or pullback, then to exit the trade before the market moves against you. Buying puts is usually most appropriate when you determine that a stock is overpriced. Added signals may include a pullback in the industry or the total market that puts added selling pressure on weak stocks.
The synthetic long or short stock position uses options to copy buying or selling a stock, with a few major differences. The synthetic long involves buying a call and simultaneously selling a put.
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Because you are selling the put, the net cost of putting on this position is less than buying calls. Although you may spend nothing for the position, the risk on the synthetic long is technically undefined. If the stock goes up, your call gains while your put becomes less expensive to buy back. Should your trade go the other way instead, you may very quickly begin to lose money. This strategy should only be considered if you are an advanced trader. Here are some of the pros and cons you should consider before moving into the market this way.
A word of caution is in order. Rookies must understand one firm principle when trading: Never place money at risk unless you are certain that you understand exactly what you are doing. There is nothing inherently wrong with paying for advice, but you must do your part and be certain that the trade is suitable for your risk tolerance see 5.
Plus, if you do not understand what has to happen for the position to make money and how it can lose money , then there is no reason to make the trade. If you begin trading any options strategy without a firm understanding of how each of these strategies works and what you are trying to accomplish when using them, then it becomes impossible to manage the trade efficiently. In other words, when trading options you cannot adopt a buy and hold philosophy. Options are designed to be traded, not necessarily actively, but when you make a trade, there is always an opportune time to exit.
Hopefully with a profit, but a good risk manager that's you knows when a specific trade is not working and that it is necessary to get out of the position. If you must take a loss, so be it. Never hold a losing trade hoping that it will get back to break even.
5 Simple Options Trading Strategies
The following short list of strategies contains the methods that I recommend. For more sophisticated traders:. These are six strategies recommended for options traders. There are other good strategies available, but these methods are that each is easy to understand. When getting started with options, it is advantageous to work with strategies that allow you to be confident that you know how to open, manage, and close your positions.
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At the top of the list is covered call writing CCW. This is a wonderful way for rookies to learn all about options. Many option rookies already understand the stock market and have investing experience. Thus, beginning with an option strategy that includes stock ownership is a logical way to introduce investors to the world of stock options.