What are the best options trading strategies? How are they executed?

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 Hello Traders,

What is Option?

Options are the contracts that allow bearers to buy or sell several underlying assets. You can do this before the contract expires or at a predetermined price. Purchase options with brokerage investment accounts. Options enhance an individual’s portfolio, which is achieved through added income, leverage, and protection. These are assets that generate recurring income. Options do involve risk in trading. As an investor, you should be aware of the associated risks.

Options are a part of securities called derivatives since their price is linked to the cost of other protection. These are financial securities’ derivatives whose value depends on other assets’ prices.

There are two basic options: the ‘Call’ option, and the ‘Put’ option. The ‘Call’ option gives the right to buy a certain number of shares of a stock or an ETF at the strike price until the contract ends. The ‘Put’ option allows holders to sell at the same time certain shares of stock or ETF at the strike price until the contract expires.


What is Options Trading?

Options can be traded in over-the-counter transactions, exchange-traded in live and orderly markets in standardized contracts form. Options trading helps in growing your income. It limits your risk and hedge against market fluctuations.

If you plan to start options trading, you should choose a broker that offers a low per-contract fee for options. It would help if you also researched for tools that can guide you with strategies that you choose along the way.

Those who want to buy options have to pay an amount called a premium to sellers for such a right. If in case, the market conditions are unfavorable for option holders, they will allow options to expire rather than exercising this right. It ensures that potential losses do not exceed the premium.

Options Trading for Beginners

  • Most brokers offer options trading online.
  • You will have to apply for options trading and need approval. You will need a margin account as well.
  • Once approved, you can enter orders for trading in a similar manner as stocks.
  • Here, you will have to use the option chain for identifying the underlying, expiration date, strike price, and if it is a ‘call’ or a ‘put’.
  • You can now place limit orders or market orders for that particular option.

Option Trading Strategies

If you plan to invest in options, you can start with calls and put options to limit the risk. There are four things that you can do while trading options:

1. Buying Calls (Long Calls)

If you believe that the price of an asset will increase, you can buy the call option using capital lesser than the asset. There is no particular limit to the profit. In case, the prices decrease, you will have to bear a lossless or equivalent to the premium paid.

Bullish traders can opt for this strategy to buy a particular ETF, stock, or index fund. Those who want to use leverage in times of rising prices.

2. Buying Puts (Long Puts)

A put option provides the holder with the right to sell the asset at a fixed price. Bearish traders with less risk tolerance and short-selling strategy can try buying puts. Traders who want to leverage when prices are falling can go for this strategy.

As the underlying prices increase, the put option gains value. Traders profit from falling prices due to short selling. There is an unlimited risk with a short position since there is no limit to how high the price will go up. If the underlying value rises higher than the option’s strike price, the option becomes worthless.

Here, the potential loss on the long put can be as much as the premium paid. The maximum profit from the position is also capped since the underlying price cannot be below zero.

3. Covered calls

Covered calls are an options trading strategy that is overlaid on an existing long position in the underlying asset. It is an upside call sold in an amount to cover the existing position size. Covered call writers collect option premiums as income and limit the upside potential of the underlying position. Traders who do have no expectations related to price change and are ready to limit upside potential instead of downside protection.

Here, the trader buys 100 shares of the underlying asset and sells a call option against those shares. The premium is collected when the trader sells the call. It lowers the cost basis on shares and provides downside protection.

In return for selling the option, the trader agrees to sell underlying shares at the price of the option’s strike. It caps the upside potential of a trader.

If the share price goes above the strike price before expiration, you can exercise a short call. Traders will be required to deliver underlying shares at the option’s strike price even below the market price.

The covered call strategy offers limited downside protection as the premium while selling the call option.

4. Protective puts

Protective puts involve the purchase of a downside put within an amount that covers the existing position in an underlying asset. You will have to pay an option premium that works as an insurance policy against losses. It can be considered as an insurance policy against losses preferred by traders who want downside protection against their underlying assets.

The option becomes worthless when the price of the underlying increases above the put’s strike price at maturity. Although the trader benefits from the increased underlying price, the trader loses the premium in this case. If the price of the underlying decreases, the position of the trader’s portfolio loses value. These losses are majorly covered by the gain from the put option position.

Levels of Options Trading

There are four different levels of options trading based on risk and complexity. Customers need approval for options trading up to a level and should maintain a margin account.

Level 1: This level includes covered calls and protective puts. It is the level for those investors who own underlying assets.

Level 2: At this level, long calls and puts options come in. This includes straddles and strangles

Level 3: These are option spreads that involve buying and selling one or more different options of the same underlying asset.

Level 4: These are selling naked options that have the possibility for unlimited losses

Futures trading and options trading is an integral part of the Indian financial markets. In futures trading, a trader agrees to either buy or sell certain assets at a specific price on a predetermined date. Here, the trader is obligated to do so. In options trading, however, traders can get the right to buy or sell a certain asset at a predetermined price on a specific date, without the burden of an obligation.

Before you trade in the derivatives market, it’s important to know how to plan, analyze and execute future and options trades. Once you understand this, you’ll find that it is easy to pick the right futures trading strategy or options trading strategy.

So, let’s take a closer look at how you can do this.

1. Perform adequate research

Research is important. It helps you plan your futures trading strategy or your options trading strategy in a more informed manner. These strategies differ from the ones you typically employ in the spot market. So, make sure to research the different aspects involved in FnO trading, like the premium, the expiry, and the margin well in advance.

2. Account for the margin money

One of the greatest perks of options trading and futures trading is that you can deal in relatively huge trades by paying small margins. However, the margin money fluctuates based on the price of the underlying stock. You’ll analyze this and ensure that you have adequate funds to meet your margin requirements.

3. Study the market

Another huge part of planning and analyzing FnO trading is studying the derivatives market as well as the spot market since the movement of the price of the underlying asset will ultimately impact the prices of futures and options. Ideally, it’s important to analyze the micro and macro influencers that impact the market, so you can plan your trades accordingly.

4. Choose the right strategy

There are different options trading strategies and futures trading strategies that you can choose from. Before you enter a trade, you’ll need to decide on the strategy. Protective puts, for instance, enhance profits on the downside. And covered calls can reduce the cost of holding.

Strangles come in handy in volatile markets. So, based on what you learned from studying the market, you can choose the right strategy.

5. Execute your trade

Once this is done, all that remains is to execute your trade. Keep the expiry and the margin requirements in mind when you get around to executing the trade since it is important to structure your trade right.

Hope this will help you.

Thank you

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