The Four Basic Stock Option Trading Strategies For Mastery
Stock option trading offers more flexibility, leverage, and limited risk than any investment vehicle today. At this point in financial history the availiability to access the derivative markets with online option trading now puts the power of these sophisticated instruments in the hands of the trader on Main Street as well as Wall Street. In contrast, the potential of these instruments can also be a little intimidating for some aspiring option traders because some strategies seem so complex. However, by gaining a foundation in four basic option strategies you can begin mastering the building blocks of all the available strategies that stock options have to offer. The basic strategies are four in number and are the long call strategy, the naked call strategy, the long put strategy, and the naked put strategy.
A long call strategy is taken when a trader is bullish on a given stock and looks to utilize the leverage of options to capture a greater gain on a stocks upward move. A call option allows the option trader to control 100 shares of a stock for a small premium while restricting his risk to just the price of the premium. This strategy allows your reward potential to be unlimited while your risk is limited to the cost of the call option. As the expiration date for the call option approaches though time decay works against this position so you must factor time into your trading decision when using this strategy.
The short call strategy is also called the naked call strategy and is implemented by allowing another trader who is the owner of a given stock to sell you the cost of a call option or the option's premium. This is an advanced bearish strategy that lets you generate income by allowing time decay to work for you if the stock falls or remains static. Unfortunately, if the stock rallies you are theoretically exposed to unlimited risk so you must have a stop point and if that is reached then you must buy back the call options to limit losses.
The long put option strategy is similar to the long call except you are bearish on a stock. When you go long a put it means you are buying a put option that controls 100 shares of a stock because you believe the stock is going to decline in value. Your risk is limited to the premium paid for the put option while your reward potential is almost unlimited. Time decay works against you on this strategy so if you use it be sure to give yourself enough time to profit.
The short put strategy, also called the naked put strategy, is used when you are expecting a stock to rise in price or remain at near the same price level for a given amount of time. Your reward is the cost of the put option if the stock rises or remains static but your risk is theoretically unlimited if the stock declines. If it falls in price and hits your stop loss point you must buy back the puts to limit your risk. This is a bullish strategy that is a short term income generator when used properly.
By taking the time to understand how each of these strategies work in a variety of market conditions you will begin to gain the foundation to master implementing them in combination. These incredibly effective risk reducing, profit enhancing instruments allow for over 60 different stock option trading strategies but all these combinations begin with these basic four strategies. As you gain mastery over how to coordinate them you will be able to put yourself in the best position to profit while maintaining the ability to limite your risk. Good trading.
A long call strategy is taken when a trader is bullish on a given stock and looks to utilize the leverage of options to capture a greater gain on a stocks upward move. A call option allows the option trader to control 100 shares of a stock for a small premium while restricting his risk to just the price of the premium. This strategy allows your reward potential to be unlimited while your risk is limited to the cost of the call option. As the expiration date for the call option approaches though time decay works against this position so you must factor time into your trading decision when using this strategy.
The short call strategy is also called the naked call strategy and is implemented by allowing another trader who is the owner of a given stock to sell you the cost of a call option or the option's premium. This is an advanced bearish strategy that lets you generate income by allowing time decay to work for you if the stock falls or remains static. Unfortunately, if the stock rallies you are theoretically exposed to unlimited risk so you must have a stop point and if that is reached then you must buy back the call options to limit losses.
The long put option strategy is similar to the long call except you are bearish on a stock. When you go long a put it means you are buying a put option that controls 100 shares of a stock because you believe the stock is going to decline in value. Your risk is limited to the premium paid for the put option while your reward potential is almost unlimited. Time decay works against you on this strategy so if you use it be sure to give yourself enough time to profit.
The short put strategy, also called the naked put strategy, is used when you are expecting a stock to rise in price or remain at near the same price level for a given amount of time. Your reward is the cost of the put option if the stock rises or remains static but your risk is theoretically unlimited if the stock declines. If it falls in price and hits your stop loss point you must buy back the puts to limit your risk. This is a bullish strategy that is a short term income generator when used properly.
By taking the time to understand how each of these strategies work in a variety of market conditions you will begin to gain the foundation to master implementing them in combination. These incredibly effective risk reducing, profit enhancing instruments allow for over 60 different stock option trading strategies but all these combinations begin with these basic four strategies. As you gain mastery over how to coordinate them you will be able to put yourself in the best position to profit while maintaining the ability to limite your risk. Good trading.
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