Which strategies should a Options Buyer use to make money?
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- Updated On:08-Jul-2021
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Short Answer
Option Buying is more common when compared to options selling. This is because option buying requires less capital and the maximum profit is uncapped. This lures many small retail traders who ultimately lose money when it comes to options buying for various reasons. Follow these strategies to increase your chances of generating profits.
Detailed Answer
Option Buying
Option buying is relatively riskier and less profitable when compared to Options selling. This is due to the reasons that option buying works against time decay or Theta Decay. Option buying is more profitable when the markets are trending. It is not easy to make money in buying options when the markets are flat or neutral.
Therefore, you should only buy an option when the underlying asset is expected to make a significant move in either direction. Option buying is profitable when the VIX (Volatility Index) is increasing. It increases the prices of options as the IV (Implied Volatility) increases with the increase in VIX. This results in the swelling up of option prices that result in profits for an Option Buyer. Let's look at some of the most effective strategies in Option Buying.
Best Strategies for Option Buying:
1. Long Straddle
This strategy can be applied when the view of the underlying asset is uncertain. It is a Delta neutral strategy that will reap profits whenever the underlying index or stock moves significantly in either direction. In this strategy, a Call & Put option has to be bough of the same underlying and at the same Strike price. There should be sufficient time left to the expiry to reduce the time decay factor. The maximum loss is limited to the premium paid and the maximum profit is uncapped making this strategy ideal when the markets are trending. The only downside is the premiums are high for buying an ATM (At The Money) option. This problem can be resolved in the next strategy.
2.Long Strangle
Long strangle is a similar strategy to the Long Straddle. This strategy can be implied when the markets are expected to make a big move on either side but the direction is unknown. In this strategy, a Call and Put option are purchased slightly OTM (Out of The Money) to reduce the cost of implementation of the strategy. This strategy becomes profitable when the underlying stock or index makes a massive move (More than 1%) in either direction. This strategy can be implemented before an event or earnings release that might result in a strong move in the stock/Index. The only downside to this strategy is that if the underlying fails to make a significant move then both the options will expire worthless (0).
These were the most useful multi-leg option buying strategies that you can use. Do remember these strategies are price neutral strategies. This means it can be employed when the trend of the underlying asset is unknown. Therefore while executing this strategy ensure the underlying asset is going to make a big move on either side.
Conclusion
Option buying seems lucrative to most small traders as the capital requirement is low. The drawback of using option buying strategies is that the chances of losses are greater than the probability of gains. Although the maximum profit is uncapped in these strategies, the maximum loss is 100% of the capital deployed. Which makes it extremely risky. Although if you follow strict stop losses and manage your risks properly you can make good money by using these strategies.
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