Options trading can be done in diverse ways. You can trade Options in unhedged or Naked positions as well as use multi-leg strategies to limit the losses. An endless combination of options can be used to put together a strategy. This can get complex sometimes. But many simple Option strategies can be used by Beginners. More of such strategies are discussed here.
Options are derivatives contracts that go up and down in value with respect to the underlying. This price volatility is used by traders to get profits. Options are contracts that are traded with a promise to exchange the underlying assets on a particular date at a particular price.
Options trading can be done in numerous alternative ways. There are single-leg or naked strategies where you can buy or sell Options. There are multi-leg options strategies that can be implemented to reduce the risks involved in options trading. Let's see some of the simplest option trading strategies for beginners.
Options trading involve many risks. To limit some of the risks, options traders use multiple options simultaneously to limit the risk. These are known as multi-leg options strategies that hedge the position. Hedged positions are easy to implement, and you can calculate the profits and losses in such strategies. let's look at some of the simple multi-leg options strategies.
Option Spread is a simple multi-leg strategy that is easy to implement. Option spread includes buying and selling of an Option in the same underlying with different strike prices. Spreads can be of various types. Bullish, Bearish, Call Spread, Put Spread, etc. Let's consider an example of a Bull Spread.
In a Bullish Spread, the view on the underlying asset has to be moderately bullish. To implement a Bull spread, you need to buy an ATM (At The Money) Call Option and Sell an OTM (Out of The Money) Call option. By this, the maximum profits are capped to the total Debit of this strategy, and the maximum profit is also limited to the spread (Difference between the 2 strike prices).
Spreads are flexible option strategies that can be implemented in countless ways. This offers the trader to have full control of the risk and reward factor of the trade.
Another simple options strategy is the 'Straddle'. This is a price neutral strategy. This means it can be implemented when the direction of the underlying is unknown. Straddles are of two types, Long straddle, and short straddle.
To implement a Long straddle the direction on the underlying can be unknown. But a massive move should be anticipated for a straddle to work. To apply a Long straddle, you have to buy a Call and Put option of the same underlying and the same expiry and at the same strike price. The maximum loss in a straddle is limited to the premium paid whereas the profit potential is unlimited. This strategy works nicely if the underlying performs a massive move of more than 2%. A Short straddle can be created in the same way by selling a Call and Put option in the same place. Here the maximum profit can be earned if the underlying expires ATM and does not perform any significant move.
These were two of the simplest hedged options trading strategies for beginners. Using hedged positions not only limits the losses but also requires less margin. You can use option buying or selling or use multi-leg strategies. The risks involved in options trading remain the same hence hedge your positions so that you are protected from any major losses and draw-downs.