Options trading has come a long way, at least in the equity sector in India. In terms of daily volumes, options are not only quite liquid but also far larger than the cash market and the futures market. Options trading for beginners is great due to its quicker price movement, resulting in faster profit generation. The best thing is that best options trading strategies for beginners can range from simple to complex that come along with different payoffs and often odd names. No matter how complex an options strategy is, there are two major elements of every best strategy for options trading – the call and the put. Let’s get to know everything about options trading strategies.
What Is Options Trading?
Understanding the best strategy for options trading may not be an easy thing. If you’re seeking for a straightforward definition of options trading, refer to the following part:
The right or obligation to purchase or sell a certain security on a specified date at a specific price is provided by options trading. A contract known as an option is one that is connected to an underlying asset, such as a stock or other property.
Options contracts are valid for a set amount of time, which may be as little as one day or as long as a few years.
When a person purchase an option, he has the opportunity, but not the obligation, to trade the underlying asset. It is referred to as exercising the choice if you choose to do so. You must meet the terms of the contract after you sell an option. Things get more difficult when selling options, and you run the danger of losing all of your money.
You have complete control over your trading choices and activities if you’re a self-driven investor exploring possibilities. However, that does not imply that you are alone. A lot of groups bring traders together to talk about the best options trading strategies they use and the condition of the stock market.
How Options Trading Works?
When a trader or investor buys or sells an option, they get the right to exercise that option at any moment up to the expiration date. An individual is not required to execute an option at the time of expiration by just purchasing or selling it.
Options are viewed as a derivative security as a result.
Types Of Options
Options trading is possible through a self-directed trading-enabled online brokerage account. Learning about the many possibilities you may trade can help you build your knowledge base about options trading for beginners. Calls and puts are the two main kinds of available choices.
1. Call Options
Consider a call option as summoning the underlying security to you; it provides you the choice to purchase an underlying asset at a certain price within a predetermined time frame. The striking price is the cost you incur. The expiry date designates the last day to exercise a call option.
Call choices come in both American and European varieties. You can purchase the underlying asset up until the expiration date using American-style options. Options of the European variety only let you purchase the asset on the expiration date.
2. Put Options
The opposite of a call option is a put option. A put option offers you the right to sell an underlying asset at a set strike price rather than the right to acquire it (think of it as moving the underlying security away from you).
There are also expiration dates for put options. When you are able to use them, the same style guidelines apply.
Important Terms Used In Options Trading
There are several terms used in Options Trading including calls, contracts, put premium, the strike rate. inherent value, and time worth. This is the jargon-filled variant of conventional stock market lingo used by options traders of all types.
Learning a few basic phrases is the first step to becoming conversant. The fundamentals of options trading for novice investors are listed below.
|Notable Terms Used in Options Trading|
|Options Trading Term||Definition|
|Options Type||There are two types of options – call and put|
|Expiration Date||The date on which the options contract turns void|
|Premium||Price of one share one pays for an option|
|Intrinsic Value||The worth of an option given the difference between a stock’s existing price and an option’s strike price|
|Time Value||The value of an option given the amount of time before the contract turns void.|
|Open Interest||The no. of options currently in play|
|Bid||The price a buyer is willing to pay for the option.|
|Volatility||A calculation of how much a stock price swings between the high and low price each day|
|Change||The price change since the previous trading day’s close, also expressed in percentage terms.|
|In the money||When the link between the stock price on the open market and the strike price is advantageous to the owner of the options contract, the option is said to have intrinsic value.|
|Holder||It refers to the investor who owns an options contract.|
10 Best Options Trading Strategies
Investors have two options when trading options: they may either acquire existing contracts or “write” or sell contracts on securities they already own. While the latter is often utilised as a method of revenue generation, the former is typically employed as a means of speculation.
Here is a deeper look at some of the best options trading strategies that all investors, regardless of experience level, should be aware of.
1. Long Call
One of the best options trading strategies is Long Call. It is when an investor makes a call option buy. It’s fairly common to use options via “going long” calls. This strategy for option trading is frequently employed by investors who anticipate that the share price of a business will increase but who do not necessarily wish to buy the stock entirely. Consequently, it is a bullish trading strategy.
2. Long Puts
Another best strategy for options trading is Long Put. Put options can be used as a hedge or to make a negative speculative wager comparable to shorting a stock. An investor will utilize a hedge to offset probable losses in other areas. Here are some instances of each usage.
Say an options trader wishes to gamble that the price of Finance Firm’s shares will decrease. Instead of buying the shares outright, the options trader buys puts tethered to a finance company. The value of such options will probably increase if the price of Finance Firm shares declines prior to the put options’ expiration date. Additionally, Options Trader can profitably sell them on the open market. It makes options trading for beginners easy.
3. Covered Calls
Shares of the underlying stock must be owned by the investor to use the covered call technique. They then receive a premium payment for writing a call option on the stock. This is one of the commonly used options trading strategies for beginners.
The exchange is that the stock shares will be called away from them and forfeited together with any future price increases if the stock climbs above the contract’s strike price. Therefore, when a stock is anticipated to remain stable or slightly decline, this options trading strategy performs well.
4. Short Puts
In this strategy for options trading, both positions are bullish, being short a put is identical to being long a call. In contrast, investors who short a put actually sell the put option and profit from the transaction. However, the seller would have to purchase those shares if the put option buyer exercised the contract.
5. Naked Calls or Short Cals
An investor who is short call options often has a negative or neutral outlook for the underlying company. Usually, the investor sells the call option to a third party. The initial investor is required to provide the stock if the call buyer exercises the option.
Similar to covered calls, short calls are called “naked calls” since the investor selling the options does not already own the underlying shares. They are thus risky and not suitable for novice investors.
6. Strangles and Straddles
Straddle is one of the best options trading strategies available today. Investors can make money using straddles in the options market independent of the movement of the underlying stock or asset. In a long straddle, the investor purchases both a call option and a put option at the same time because they expect increased volatility. The converse is true with short straddles, where investors simultaneously sell a call and a put.
When fluctuation in the underlying asset is anticipated to be minimal or neutral, strangles and straddles are utilized.
An investor purchases a call and a put with two separate strike prices in a long strangle. They probably think the stock will move upwards more often than downwards or vice versa because of this. An investor sells a call and put with two distinct strike prices in a short strangle.
7. Bull Put Spreads
Now look at this one of the best options trading strategies. One long put with a lower strike price and one short put with a higher strike price make up a bull put spread. The underlying security and expiration date of both contracts are the same. This tactic aims to gain from an increasing stock price. A bull put spread, however, minimises losses and can make money through time decay unlike a standard call option.
8. Cash-secured Puts
When an investor employs this best strategy for options trading, they often have a positive to neutral perspective on the underlying asset. The option writer keeps the premium and receives discounted shares. Alternatively, the writer will only receive the premium and no shares if the company moves sideways.
9. Butterfly Spreads
A butterfly spread can be created with either calls or puts and combines a bull spread with a bear spread. The butterfly spread has four distinct choice legs, just as the iron condor. When a stock is anticipated to remain largely flat until the options expire, this tactic is employed.
10. Iron Condors
When a stock is believed to have little volatility, the iron condor, which has four option legs (two calls and two puts), is intended to generate a tiny profit in a low-risk manner. Let’s look at the four legs. Same expiration date applies to all four contracts:
1. Purchase a put with a lower strike price that is out of the money.
2. Create a put with a strike price that is more in line with the asset’s current value.
3. Make your call have a higher strike.
4. Purchase an additional higher out-of-the-money strike call.
Levels Of Options Trading
Along with the understanding of best options trading strategies, you should educate yourself on the many degrees of trading approval levels if you want to get in options trading. There are many levels of trading, and even some seasoned traders may not be aware of them or know how to determine what level they are trading at right now.
You may trade more effectively and intelligently by being aware of these levels and how brokers calculate where traders should be.
Since options are inherently leveraged securities, margin is typically available to traders in brokerage accounts that support the trading of options. Because the trader is utilizing the brokerage’s funds when trading on margin, consumers of brokerage companies may be exposed to potentially dangerous positions.
The brokerages employ trading approval levels to establish what kinds of contracts and transactions each customer is permitted to execute in order to protect themselves from unneeded risk. Although each brokerage may refer to the levels differently, they are often categorised as Levels 1 through 4. Traders will discover that access to margin comes with consecutive increments in their existing level with further clearance.
Level 1- Covered Calls
Because it is the safest, lays the least amount of risk on the broker, and guarantees that the trader can pay any losses, Level 1 is where the majority of rookie traders will start.
Because they already hold the shares needed to cover a contract they write or have the funds to do so, novice options traders are well-suited to covered calls.
Consider a trader who wants to start trading options and who now holds 1,000 shares of the stock XYZ in their brokerage account. She completes the form with the help of her broker, who makes note of her ownership of XYZ and the fact that she has little to no experience trading options.
She is granted Level 1 options trading status, which permits her to sell covered calls, after her application has been filed and evaluated. She is qualified to write 10 contracts since she owns 1,000 shares of XYZ, and each option contract corresponds to 100 shares. The order would not be processed if she attempted to write more than what her shares allowed.
Level 2- Buying Calls, Puts, and Selling Secured Puts
Numerous new tactics that let investors speculatively predict price changes are made available at the second level of options trading for beginners.
The ability to purchase long calls and puts is level 2’s main advantage of this best strategy for options trading. The maximum loss for the trader is 100% of the premium paid for the contract, although purchasing calls and puts does not subject the brokerage to additional risk.
Buying a call option on the stock with a strike price higher than the stock is presently trading would be lucrative if the stock price rose above the strike price of the contract if a trader is long (bullish) on ABC Corp and wants to profit from the increase in the stock price. The option will expire worthless if the stock does not rise high enough or falls.
On the other hand, if a different investor were short (bearish) on ABC Corp., then purchasing a put option would allow the investor to profit from a decline in the stock price. The contract would be beneficial if the share price dropped below the strike price, at which point the investor may sell the put option for the premium earned on the difference. The option will lose value if the stock remains stable or increases.
Selling Secured Puts
Similar to covered calls, cash secured puts demand that the seller lay aside the cash necessary to purchase the shares of stock in the event that the option is assigned.
Using this tactic, the trader anticipates a drop in the stock price and an exercise of the contract by the contract buyer. When the agreement is put into action, the seller will pay less for the allotted shares and then sell them to the buyer.
The trader may profit from the assignment of the shares, but there is a significant chance that the share price may not increase, and the seller will incur a loss by selling the shares back to the buyer at a price greater than the assignment price.
Level 3- Spreads
The brokerage may classify an investor as a level 3 trader if the trader has gained some expertise and established a reliable trading routine. The trader may execute sophisticated transactions like spreads, iron-condors, or iron-butterflies at Level 3 by taking numerous positions.
Spreads and comparable tactics need a thorough understanding of option mechanics as well as a sizeable investment. After reaching level 3, traders will have access to margin to execute transactions.
Level 3 traders have been screened and given the go-ahead to utilise margin, despite the fact that doing so might be dangerous for the brokerage. In order for the trader to be approved, the brokerage may analyse their transactions and set a minimum capital requirement for the accounts.
Level 4 – Uncovered Calls and Puts
The highest degree of option clearance entails the most risk for the brokerage as well as the trader. Naked options offer a limitless potential for both gains and losses.
Purchasing a naked option, whether a call or a put, offers the chance for endless profit. The profit is only capped by how far the stock rises less the premium paid if a trader buys an out-of-the-money call and the price soars.
Advantages And Disadvantage Of Options Trading
The use of options as a component of your investing plan has both many advantages and disadvantages. Before you decide whether to include options in your portfolio, it is essential to comprehend both.
Lower financial obligation: Options allow you to avoid paying cash to buy actual shares of stock if you want to profit from a stock’s price movement. As a result, compared to your initial investment, your prospective return might be significantly larger while choosing the best strategy for options trading.
Less danger for buyers: Whether you purchase call or put options, you are not required to decide whether to buy or sell the contract’s underlying stock. Only the contract premium will be lost if things don’t work out for you.
More trading freedom: You might use options to hedge your present assets, generate extra income from stock you currently own, or employ other tactics to meet your financial objectives, depending on the type of option and your position as the buyer or seller.
They are challenging: You must comprehend the rules and language that are specific to options. As a result, it’s advisable to stay away from them until you’ve gained a significant amount of trading experience and spent the time researching how they operate.
Sellers face a high risk of loss: You run the risk of suffering a loss that is far bigger than the profit you get from the contract’s premium whether you sell a call or a put option.
Nobody can just do it: You must have your brokerage firm’s clearance before you may trade options. You must agree to maintain a minimum amount in your brokerage account as cash reserves and respond to a series of questions.
Whether prices are rising, falling, or moving sideways, options trading tactics provide a chance to possibly benefit in nearly every market condition. The market is complicated and very hazardous, making it unsuitable for everyone. However, the aforementioned book outlines several trading techniques based on the investor’s level of experience. If you are looking for the best strategy for options trading, you can choose from the aforementioned approaches.
Qu1. What are the best stocks for option trading?
Ans. According to the stock market experts, some of the top-picked stocks for option trading are Bajaj Auto, Apollo Tyres, HDFC Bank, Dalmia Bharat, Adani Enterprises, etc.
Qu2. Who is best option trader in India?
Ans. Zerodha is considered the best option trader in India. It charges a brokerage of flat Rs. 20 per executed order regardless of the lot size. In addition, it offers 3 times or 40% NRML margin.
Qu3. Is option trading better than stocks?
Ans. Options prices may be even more erratic than stock prices, which is one of the things that draws traders to them because of the probable profits. Though options are normally hazardous, some options techniques can be low risk and potentially increase your stock investment profits.
Qu4. What is the best strategy for options trading?
Ans. Bull Call Spread is considered the best options trading strategy as it endeavors to reduce the trade’s initial investment while yet profiting from a favourable market. When the price of the underlying asset closes higher than the higher strike price at expiry, the maximum profit potential is realized.
Qu5. What is the best way to learn options trading for beginners?
Ans. In today’s competitive environment, there are both online and offline resources available to help you learn the basic and advance-level options trading. However, if you want complete full-fledged support, you can try Compare Broker Online which is known to provide the most effective learning support for options trading.
Qu6. Can a beginner trade in options trading?
Ans. Yes, a beginner can easily choose to trade in options trading.
Qu7. What is a strangle in options?
Ans. Call and Put options are both a part of the strangle options strategy, which is an options strategy. Both contracts have the same underlying asset and expiration date, but different strike prices. Investors utilise the strangle options strategy when they believe the underlying asset will suffer significant price movement in either the upward or downward direction.
Qu8. What is future and option trading?
Ans. Investors might speculate on changes in market price or utilise financial derivatives like options and futures to manage risk. An investor can purchase a security at a set price by a specific date using both options and futures.
An option allows the buyer the freedom to purchase (or sell) an asset at a predetermined price at any point during the term of the contract, but it does not obligate them to do so. A futures contract binds the buyer to buy and the seller to sell and deliver a certain asset at a predetermined future date.