In the world of online trading, there are numerous paths you can choose to take depending on the assets you have at your disposal, your preferred trading strategy and the type of trading you find most appealing. However, it’s important to mention that your trading experience will also play a huge role in determining the type of trade you’ll be most successful at.
That’s why, if you are a beginner and are only learning the ropes of trading, you should definitely consider trading options. If you are not familiar with the term or you don’t quite know what options are and how you can trade them, here’s a helpful guide that will make the entire process a bit easier to understand and should aid you in choosing the best options trading strategy. Check it out.
What are options?
Simply put, options are basically contracts that allow the option holder (the owner of the contract) to buy or sell a security at a predetermined price. In order to be able to do so, option buyers are charged a “premium” by the seller. In case the market prices of the securities drop or become unfavourable for the option holder in any other way, the holder may choose to let the option expire. This way, the option holder will ensure that the losses are not higher than the premium paid. On the other hand, option writers (the person selling the options) take on a greater financial risk than option buyers (holders) which is why options trading is such a popular trading style.
Now that we’ve made options trading a bit clearer, let’s see what some of the best strategies for beginners are and how to use them to your advantage.
Long call
This options trading strategy is preferred among bullish traders that want to limit their risks and take advantage of rising prices. In this case, options allow traders to boost their benefits by choosing to risk smaller amounts than they would be required to if they were trading the underlying asset itself. What this basically means is that a standard option on a stock controls 100 shares of the underlying security. The risks and potential losses from a long call are limited to the premium paid while the potential profit is unlimited.
Long put
While a long call is preferred among the bullish traders, this one is more suited for bearish traders who want to take advantage of falling prices. This one works the exact opposite way from a call option. Here, a put option is gaining in value as the price of the underlying asset decreases. Unlike with short-selling where a trader can profit from falling prices, but the risk is unlimited, with the put option there’s a way to limit the risk. Simply put, if the price of the underlying asset rises beyond the options strike price, the option will simply expire and become worthless. So, the potential loss is limited to the premium paid, but the maximum profit is capped.
Covered call
This strategy is mostly preferred by traders that expect little to no change in the price of the underlying asset and are willing to limit their gains in exchange for some downside protection. This option strategy allows you to purchase 100 shares of the underlying asset and sell a call option against those assets. Basically, when the trader sells the call, they can collect the option’s premium and, in this way, lower the cost of shares. When the trader sells the option, they are agreeing to sell the shares of the underlying asset at the option’s strike price.
This way the trader’s upside potential is capped. So, if the share price rises above the strike price before the due date, the trader will have to deliver shares at the option’s strike price, even if that price is below the market one. On the other hand, the premium received when selling this option will be the trader’s limited downside protection.
Protective put
Finally, a protective put is an excellent strategy for traders who are the owners of the underlying asset and want to have some downside protection. This strategy is similar to a long put, but unlike the long put it doesn’t attempt to profit from a downside move. Rather, it protects the trader against it. Simply put, if the underlying’s price increases above the put’s strike price, the option will expire worthless and the trader will lose the premium but will still be able to benefit from the increased underlying price.
These four option trading strategies are most popular among beginner traders because they offer the same level of risk and security so that nobody involved is experiencing a significant loss. Therefore, make sure to check them out if you are considering entering the world of trading.
This article is for information and educational purposes only and does not form a recommendation to invest or otherwise. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.