Best Options Strategies Every Investor Should Know

Options contracts are a type of derivative contracts based on the underlying asset's prices. It gives the holder the right but not an obligation to buy/sell the underlying asset at a pre-determined price before a pre-set date. However, options trading is not as simple as this definition. It requires a deep understanding of factors affecting the asset's price movements and their impact on the option’s value. Traders use many strategies to navigate the complex world of options trading successfully. Here is a brief outlook into a few top options trading strategies that every investor must know. 

Bullish Option Trading Strategies

Bullish options strategies are used by traders aiming to take advantage of the upward price movement of the underlying asset. Popular bullish options trading strategies include.

Bull Call Spread

A bull call spread involves buying a call option at a lower strike price and selling another at a higher strike price, both with the same expiration date. This strategy lowers entry costs compared to a single-call option. Maximum profit is achieved if the asset's price is at or above the higher strike at expiration, while the maximum loss is limited to the net premium paid. This strategy offers a balanced approach, limiting both potential profit and risk.

Bull Put Spread

A bull put spread is created by selling a put option at a higher strike price and buying another put option at a lower strike price, both with the same expiration date. This strategy generates income through the net premium received and benefits from an upward or stable asset price. The maximum profit is the net premium earned if the asset's price stays above the higher strike price at expiration. The maximum loss is limited to the difference between the strike prices minus the net premium received, making it a defined-risk strategy.

Long Call Butterfly Spread

A long call butterfly spread is a more complex strategy that involves three strike prices. The trader buys one call option at the lowest strike price, sells two call options at a middle strike price, and buys another call option at a higher strike price. This strategy benefits from a moderate rise in the asset's price, with the maximum profit occurring if the asset's price is near the middle strike price at expiration. The maximum loss is limited to the initial investment, making it a low-risk strategy with a well-defined profit range.

Bearish Option Trading Strategies

Bearish options strategies are used by traders aiming to take advantage of the downward price movements of the underlying asset or to hedge against potential losses in a declining market. Popular bearish options trading strategies include -

Bear Put Spread

A bear put spread involves buying a put option at a higher strike price while simultaneously selling another one at a lower strike price, both with the same expiration date. This strategy reduces the cost of entering a bearish position compared to buying a single put option. The maximum profit is achieved if the asset's price is at or below the lower strike price at expiration, while the maximum loss is limited to the net premium paid for the spread. 

Bear Call Spread

A bear call spread involves selling a call option at a lower strike price and buying another at a higher strike price, both expiring on the same date. This strategy generates income from the net premium received and benefits from a stable or declining asset price. The maximum profit is the net premium if the asset's price remains below the lower strike at expiration. The maximum loss is limited to the difference between the strike prices minus the net premium.

Long Put Butterfly Spread

The long put butterfly spread is a nuanced strategy employing three strike prices. It involves buying a put option at a higher strike, selling two puts at a middle strike, and buying another put at a lower strike, all expiring together. This tactic thrives on a modest drop in asset value, offering maximum profit near the middle strike at expiration. Losses are capped at the initial investment, ensuring a low-risk approach with defined profit boundaries.

Neutral Option Trading Strategies

Neutral options trading strategies are used by traders who expect little price movement of the underlying asset and aim to profit from low volatility or stable price scenarios. 

Calendar Spread

A calendar spread strategy involves buying and selling options with different expiration dates but the same strike price. Traders use this strategy when they expect minimal price movement in the short term but anticipate volatility or significant price movement in the long term. The maximum profit occurs if the asset's price is near the strike price of the sold option at its expiration, allowing the trader to sell another option. The maximum loss is limited to the initial investment if the asset's price moves significantly away from the strike price.

Iron Condor

The iron condor is a widely-used neutral options strategy involving selling out-of-the-money call and put spreads simultaneously on the same underlying asset, expiring together. Traders employ this when anticipating the asset's price to stay within a defined range. The maximum profit is the net premium received from both spreads which occurs if the asset's price stays between the strike prices of the sold options at expiration. The maximum loss is limited to the difference between the strike prices of the call or put spreads, minus the net premium received, making it a defined-risk strategy.

Iron Butterfly

The iron butterfly strategy merges features of both the iron condor and butterfly spread and is suitable for anticipating minimal price shifts and low volatility. It comprises selling at-the-money call and put options while buying out-of-the-money call and put options, all expiring together. The maximum profit is the net premium received if the asset's price remains near the strike price of the sold options. The maximum loss is limited to the difference between the strike prices of the bought and sold options, minus the net premium received.

Intraday Option Trading Strategies

Intraday option trading strategies refer to techniques used by traders to capitalise on short-term price movements within a single trading day. 

Scalping

Scalping is an intraday options trading strategy where traders aim to profit from small price movements in the underlying asset. Traders enter and exit multiple trades throughout the trading day to capture small price changes and accumulate profits. This strategy requires quick decision-making, precision timing and the ability to execute trades efficiently. Scalping in options involves leveraging short-term price fluctuations to generate profits by using technical analysis indicators such as moving averages, MACD, or RSI to identify potential entry and exit points.

Volatility Trading

Volatility trading strategies in intraday options trading involve taking positions based on expected changes in implied volatility levels. Traders may buy options when they expect volatility to increase (volatility expansion) or sell options when they anticipate volatility to decrease (volatility contraction). This strategy can be profitable during periods of heightened market uncertainty, news events, or market reactions to economic data releases. To make informed trading decisions, volatile trading strategies require analysis of options pricing, implied volatility levels, and market sentiment.

Conclusion

Options trading is a complex world that requires a deep knowledge of concepts like Greeks, time decay impact and implied volatility, and price deviations in the underlying asset. The various option trading strategies give traders an edge. However, it is important to understand how options work and the strategies discussed above before you start options trading.