Call options and put options are the 2 primary style of option strategies. Below is a transient overview of learn how to profit from using these options in your portfolio.
Key Takeaways
- For beginners, there are several basic options strategies that provide relatively easy structure and easy profit & loss outcomes.
- Buying options could be used for defense from risk, or to invest without risking much on the downside.
- Writing covered options can provide extra income with limited risk.
- More complex combination and spread strategies are also available, but may require a more in-depth understanding of options trading.
Puts And Calls
A call option provides an investor with the best, but not the duty to buy a stock at a selected price. This price is often known as the strike, or exercise price. A put option provides an investor with the best, but not the duty to sell a stock at a selected price. This price can be often known as the strike, or exercise price. Other necessary contract terms include the contract size, which for stocks is normally in denominations of 100 shares per contract. The expiration date specifies when the choice expires, or matures. The contract style can be necessary and could be in two forms. American options let an investor exercise an option any time before the maturity date. European options can only be exercised on the expiration date.
Writing Call Options for Income
Buying a call option is similar as going long or benefiting from an increase within the stock price. As with stocks, an investor also can short or write a call option, receiving the premium. The decision author has the duty to sell the stock to the decision option holder if the stock price rises above the exercise price.
In writing call options, the investor who is brief is betting that the stock price will remain below the exercise price in the course of the term of the choice. So long as this happens, the investor earns income from the strategy together with the premium.
Three Ways to Profit Using Call Options
Combining One Call with One other Option
To create a more advanced strategy and reveal using call options in practice, consider combining a call option with writing an option for income. This strategy is often known as a bull call spread and consists of shopping for, or going long a call option and mixing it with a brief strategy of writing the identical variety of calls with the next strike price. On this case, the intention is to take advantage of a narrow trading range.
For instance, assume a stock trades at $10, a call is purchased at a strike price of $15 and a call is written at $20 for a premium of $0.04 per contract. This assumes a single contract for premium income of $4, or $0.04 x 100 shares. The investor will keep the premium income whatever the situation. If the stock stays between $15 and $20, the investor retains the premium income and likewise profits from the long call position. Below $15, the long call option is worthless. Above $20, the investor keeps the premium income of $4 in addition to a $5 take advantage of the long call option, but loses out on any upside above $20 because the short position means the stock might be called away.
Writing Put Options for Income
Buying a put option is analogous to going short on a stock, or benefiting from a fall within the stock price. Nevertheless, an investor also can short, or write a put option, receiving the choice premium in hopes that the stock stays above the strike price. If the stock falls below the strike price, the put author has the duty to purchase the stock (since it is effectively “put” to the author) from the put option holder. Again, this happens if the stock price falls below the exercise price.
When writing put options, the investor who is brief is betting that the stock price will remain above the exercise price in the course of the term of the choice. So long as this happens, the investor earns income from the strategy together with the premium.
Combining One Put with One other Option
To create a more advanced strategy and reveal using put options in practice, consider combining a put option with a call option. This strategy is often known as a straddle and consists of shopping for a put option in addition to going long a call option. On this case, the investor is speculating that the stock goes to have a comparatively significant move either up or down.
For instance, assume a stock trades at $11. The straddle strategy could be relatively straightforward and consist of buying each the put and call at a strike price of $11. Two long options are purchased with the identical expiration date and a profit is reached if either the stock moves up or down by greater than the fee to buy each options.
Assume shares of XYZ recently traded at $11 per share. A call option costs $0.20 and a put option costs $0.15 for a complete cost of $0.35. On this case, the stock has to rally above $11.35 for the decision choice to repay and below $10.65 for the put option to repay.
The Bottom Line
These easy call and put option strategies could be combined with an enormous array of more exotic positions to generate profits and control risk.