Posts Tagged ‘options trading strategy’

Understanding an Options Trading Strategy

Wednesday, December 9th, 2009

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Do you know what an options trading strategy is? If you work with a broker and have an investment portfolio then you may want to take some time to understand this concept. Just like the rest of the financial market, the options trading industry requires the investor to have an understanding of current conditions, the performance of their holdings, and any anticipated changes that might yield (or lose) income.

Clearly this means that an options trading strategy is necessary for the most beneficial results. The main question then is how to go about developing a strategy? That requires clear-cut goals and plans, but options trading is such a flexible activity that it can help all kinds of investors to meet their goals.

Consider that there can be an options trading strategy in place for times when the markets take a nose dive, improve dramatically, or even when they remain stable or neutral for a long period of time.

Perhaps it is best to first explain a bit about the various activities available to those who are interested in options trading, and how these can be strategically used towards the meeting of financial goals.

In the world of options trading, the investor can choose to both buy and sell – just like those working in the stock markets. The main difference is that those selling and buying options may never have to actually own the underlying assets. Instead, they are working with legal contracts around the performance of those financial vehicles and then gaining or losing financially based on the terms of the contract.

For example, an investor may believe that a particular stock (for which they do not own any shares) is going to increase dramatically in value over the course of the coming weeks. They do not, however, have the income to make the investment in the actual stocks at the current time. Instead, they purchase a “call” option that guarantees them the opportunity to make a purchase of the stocks at a fixed price for a specific period of time. If the stock does indeed spike in value before the option expires the investor can either make the purchase at the significantly lower price, or they can sell the option for a profit instead.

This exchange is not free of charge, and this is where a good strategy must be in place in order to identify if the “strike price”, the “premium” for the option, and the “expiration date” on the contract will all add up to the amount of profit desired.

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An Options Trading System to Cut Losses

Thursday, November 12th, 2009

One of the main principles of any successful options trading system is to hold onto your gains and cut your losses.  Some traders even consider this to be the most important principle of trading.  Unfortunately, the heavy losses suffered by options traders year in and year out indicate that many people are not adhering to this principle.

Fortunately, there is an options trading system you can use to cut your losses and walk away a winner—even if things aren’t going according to plan.  In fact, this particular trading strategy is designed to protect your core investments against adverse market movements.

Known as protective equity puts, this options trading system works with your existing stock portfolio.  It functions as a way to arrest a downward slide in share price—at least for your personal portfolio.  It is an effective strategy to use if you are worried about market uncertainty or future falls and would like to get a bit of insurance to protect yourself against a heavy financial loss.

To use this options trading system, you need to identify the stocks in your portfolio that you are bullish about in general, but worried about overall.  Although protective equity puts have traditionally been used only on individual stocks, they can also be used for ETFs and some index funds.  In this way, you can get insurance on most of your existing portfolio.

Once you have your list together, you will want to determine what percentage of each position you would like to protect with puts.  Most traders opt to insure the entire position, although depending on your reasoning and motivation for being in the stock in the first place you may opt for a partial put option.  Either way, remember that protective equity puts are sold in units of 100 shares, so you will want to even out your investments accordingly.

The next stage is to bookmark your current share prices.  This will serve as a reference point on your protective equity puts.  You will want to buy your protective equity puts for a share price that is just below the current share price of the stock.  These puts give you the right to sell your holdings at the price you’ve lock in at a future date.

Depending on your confidence in the market, the size of the investment, and the market trends you are working with, you may choose short term or long-term contracts for the puts.  If you want to lock in profits as you go, you can choose shorter dates for the puts and renew them at slightly higher share prices as the underlying stock rises.

If the stock goes down, with the protective equity puts in place you will be able to close out the position with a relative small loss.  If you determine that even at the lower price you’d like to keep your holding, you are under no obligation to sell it and can simply let the protective equity puts expire.  Its an options trading system that many stockholders over look, but it can protect you against financial ruin.

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Options Trading Strategy – The 4 Basic Option Trades

Friday, October 30th, 2009

The foundation of any options trading strategy revolves around 4 basic trades that beginner option traders need to master. Combining these 4 basic option trades with both long and short positions allow for many more types of options trades.

Here are the 4 basic option trades which will serve as key building blocks within your options trading strategy:

The long call:

An option trader who believes in a particular stock price increasing could choose to purchase the right to buy the underlying stock – know as a call option – instead of purchasing the actual stock.

The option trader would be under no obligation to purchase the stock itself. The individual would simply have the right or option to do so until the option expiration date.

Should the price of the stock at expiration be greater than the exercise price and premium price (the price of the stock options) – combined – the trader will profit on the trade.

Should the price of the stock at expiration be less than the exercise price and premium price (the price of the stock options) – combined – the trader should let the stock option expire worthless, losing only the amount spent on the option premium.

The long put:

An option trader who believes that a particular stock’s will drop may decide to purchase the right to sell the stock at a fixed price – otherwise known as a put option. The trader is under no obligation to sell the underlying stock, but simply has the right to sell the underlying stock on or before the expiration date.

If the price of the underlying stock on the expiration date is below the exercise price by more than the premium (the price paid for the option), the trader will profit from the trade. On the other hand, if the stock price at expiration is greater than the exercise price, the trader should allow the put contract to expire worthless, losing only the premium (price of the option) paid.

The short call:

An option trader who believes that a particular stock price will decrease, may choose to sell or “write” a call. The seller of the call is under no obligation to see the stock to the buyer at the buyer’s option.

If the price of the stock goes down, the short call position will profit on the trade in the amount of the premium (the price paid for the option).

Should the stock price increase to a price greater than the exercise price by an amount greater than the premium amount , the short will incur a loss on the particular trade, with the potential loss being unlimited.

The short put:

An option trader who thinks that a particular stock price will increase may choose to purchase the stock or sell a put. The trader who sells the put is obliged to purchase the stock from the put buyer at the buyer’s option. In the case that the stock price at expiration is greater than the exercise price, short put position will make a profit equaling the premium (the price paid for the option). On the other hand, if the stock price at the time of expiration is below the exercise price by more than the amount of the premium, the trader will incur a loss up to the full value of the stock in question.

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