What is the Best strategy for Options Trading?
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- Updated On:03-Mar-2021
- Replies:2
Short Answer
There are many complex Option Trading strategies out there but the most profitable are some of the simpler ones. The top 3 of them are Long & Short Straddles, Long & Short Strangles and Bull/Bear spreads.
Detailed Answer
Top 3 Option Strategies
Options trading can be highly profitable if executed at the right time and with the proper hedge. Naked option buying is like buying a lottery ticket where the chances of getting the lottery are very slim hence proper hedging is necessary to mitigate the risk and maximize the gains.
The top 3 options strategies are as follows- where the first 2 strategies are price neutral strategy where you can make money whether the prices move up, down, or sideways, and the other is a directional strategy where you make money if the anticipation of your price movement (up or down) is right.
1. Long & Short Straddle-
Let's understand these in detail:
Long Straddle
The Long Straddle, is a neutral strategy that involves buying of 1 ATM or At-The-Money Call option and 1 ATM Put option of the same underlying asset at the same point of time and of the same strike price. This strategy is implemented when you expect a big move in either direction. You will make money if the price of the underlying asset goes up or down significantly and will only lose only if it stays sideways. The maximum loss is the amount of the premium paid but the potential profit is uncapped.
Short Straddle-
Opposite to the long straddle, now 1 ATM Call option and 1 ATM Put option has to be sold for the same underlying asset and for the same expiry. In this strategy, the maximum profit is earned when markets remain sideways and the maximum margin of safety is the premium collected, beyond that your losses will begin when the price moves wildly in any direction.
2. Long & Short Strangle-
The strangle is almost similar to the Straggle strategy but the cost of implementation is significantly less than that of a straddle. It is also a neutral strategy where you make money if the price goes up, down, or remains sideways.
For a Long strangle you have to buy 1 OTM or Out-of-the-Money Call option as well as 1 OTM Put option of the same underlying asset and of the same expiry. Ex - if Reliance is trading around 2000 then you will have to buy a 2100 CE and a 1900 PE. In this strategy, the underlying asset is anticipated to move significantly in either direction,5% minimum in this case.
On the other hand, when you expect markets to trade in a range or remain sideways, a Short Strangle is implemented. For this, you have to Sell 1 OTM Call option and 1 OTM Put option. The maximum profit in this strategy is the net premium collected and the loss is uncapped If the price goes up or down significantly.
Bull/Bear Spreads-
In a spread, a combination of both buying as well as selling options is involved. Your outlook for the underlying asset has to be moderately bullish or bearish.
For implementing a Bull call spread you need to buy an ATM Call option and sell an OTM call Option. Both the options should be of the same expiry and of the same underlying asset. For example, if Nifty is trading at 15000, and the outlook is moderately bullish then you have to buy a 15000 CE and sell a 15400 CE. So in this case, if Nifty moves up by 200-300 points, you will make money. The maximum profit and loss are capped in this strategy.
Similarly when you expect the price to fall then you can implement a Bear Put Spread- in order to implement this strategy the Index/Stock should be moderately bearish. For implementing this strategy you will have to buy 1 ITM or In-The-Money Put option and sell 1 OTM Put option. This strategy is similar to the previous strategy where the maximum profit and loss is capped where the maximum profit is the Spread (Difference between the strike prices)- Net debit and the maximum loss is the Net debit in this strategy.
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Discussion (1)
Option Spreads are usually used to hedge a position and try to increase the chances to make money. By doing this we limit our profits but most importantly we minimize our losses that is the most important part in trading, which is to preserve our capital.
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While there are many strategies in the market for options trading, you could buy multiple contracts of CE and PE. But then always keep on thing in mind that you need to set your stop loss to prevent losses. Furthermore, in options strategy never invest too early or too late, always have a certain level of entry and exit to book profits.