Options trading strategies can be broadly categorized into directional (predicting price movement) and non-directional (benefiting from volatility, time decay, or specific market conditions). Here are some popular strategies used in the market:
1. Directional Strategies
These strategies are based on anticipating the underlying asset’s price movement (up or down).
a. Long Call
• Outlook: Bullish
• Description: Buy a call option to benefit from upward price movement.
• Risk: Limited to the premium paid.
• Reward: Unlimited (theoretically).
b. Long Put
• Outlook: Bearish
• Description: Buy a put option to profit from downward price movement.
• Risk: Limited to the premium paid.
• Reward: Substantial (price can drop to zero).
c. Covered Call
• Outlook: Neutral to mildly bullish.
• Description: Own the underlying asset and sell a call option to earn income.
• Risk: Limited upside (call cap) and full downside of the stock.
• Reward: Premium collected.
d. Protective Put
• Outlook: Bullish with downside protection.
• Description: Own the underlying asset and buy a put as insurance.
• Risk: Premium cost for the put.
• Reward: Unlimited upside minus the premium.
2. Income Strategies (Neutral Market)
These strategies generate income through time decay (Theta).
a. Cash-Secured Put
• Outlook: Neutral to bullish.
• Description: Sell a put option while holding cash to buy the stock if assigned.
• Risk: Downside is the strike price minus the premium.
• Reward: Premium collected.
b. Iron Condor
• Outlook: Neutral (range-bound market).
• Description: Combine a bull put spread and bear call spread to profit from low volatility.
• Risk: Limited to the difference between strikes minus the premium.
• Reward: Premium collected.
c. Iron Butterfly
• Outlook: Neutral.
• Description: Sell a straddle (short call + short put) and buy protective wings at different strikes.
• Risk: Limited to the difference between strikes.
• Reward: Premium collected.
3. Volatility Strategies
These strategies take advantage of high or low volatility expectations.
a. Straddle
• Outlook: Expecting high volatility (large price movement).
• Description: Buy both a call and put at the same strike price.
• Risk: Limited to the combined premium.
• Reward: Significant if the price moves sharply in either direction.
b. Strangle
• Outlook: Expecting high volatility (large movement, but unsure of direction).
• Description: Buy a call and a put at different strike prices.
• Risk: Limited to the combined premium.
• Reward: Substantial if the price moves beyond the breakeven points.
c. Calendar Spread
• Outlook: Expecting low volatility in the near term.
• Description: Sell a short-term option and buy a longer-term option at the same strike price.
• Risk: Limited to the net debit.
• Reward: Substantial if the stock price stays near the strike price.
4. Hedging Strategies
These reduce risk for existing positions.
a. Collar
• Outlook: Protective but limits upside.
• Description: Buy a put option and sell a call option at different strike prices.
• Risk: Downside limited by the put.
• Reward: Capped by the call.
b. Ratio Spread
• Outlook: Mildly bullish or bearish.
• Description: Sell more options than you buy (e.g., sell 2 calls and buy 1).
• Risk: Unlimited in certain setups.
• Reward: Premium collected.
5. Advanced Strategies
These involve complex multi-leg positions for specific outcomes.
a. Diagonal Spread
• Outlook: Moderate movement and specific time horizon.
• Description: Buy a long-term option and sell a short-term option at different strikes.
• Risk: Limited to the initial debit.
• Reward: Can be substantial with proper timing.
b. Jade Lizard
• Outlook: Neutral to bullish.
• Description: Combine a short put and short call spread to avoid upside risk.
• Risk: Downside only from the short put.
• Reward: Premium collected.
c. Box Spread
• Outlook: Arbitrage or capital guarantee.
• Description: Combine a bull call spread and bear put spread to lock in risk-free profit.
• Risk: Minimal (execution-related).
• Reward: Risk-free return minus commissions.
6. Earnings and Event-Driven Strategies
• Straddle/Strangle: For earnings announcements or major events where large price moves are expected.
• Reverse Iron Condor: For expected volatility spikes.
Key Factors in Strategy Selection
- Market View:
• Bullish, bearish, or neutral.
- Volatility:
• Use high IV for selling strategies (Iron Condor).
• Use low IV for buying strategies (Straddle).
- Risk Appetite:
• Aggressive (Straddle, Naked Options).
• Conservative (Covered Calls, Protective Puts).
- Time Horizon:
• Short-term (Straddle for earnings).
• Long-term (Diagonal Spreads).
- Capital Requirements:
• Some strategies (e.g., Covered Calls) require significant capital.
Tools and Platforms
• Backtesting Tools: Analyze historical performance of strategies.
• Option Analytics Platforms: Platforms like Thinkorswim, Tastyworks, or OptionsPlay.
• Greeks Calculators: Understand risk sensitivities of options.