Picking Out Some Good Strategies to Use with Options Trading
One of the first things that you will need to do once you decide to enter the market is pick out a good strategy to use. This strategy is so important because it helps you to know when to enter the market, what to look for in the market, and even when you should leave the market. When it comes to options trading, there are actually quite a few strategies that you can choose to work with. Some of the best choices in strategies include:
Tip 11: Working with a fundamental analysis
The first strategy we are going to take a look at is the fundamental analysis. This is a method that doesn’t spend so much time looking at the charts as some of the others. Instead, the trader who uses this is trying to find an underlying asset that they believe to be undervalued at the time, for some reason or another. They hope that once they find it, they will be able to do a fundamental analysis to determine whether the price of this security is going to go up.
There are many things that you need to look at when it comes to a fundamental analysis. Understanding why the asset is undervalued is important as well. As a fundamental analyst, you will take a look at the debt ratio the company has, how long it has been in business, whether it has seen an increase in profits over the past five years, whether it is growing, who manages the business, and so on. The hope is to find an asset that is undervalued, and then purchase it before public opinion changes and the price goes up.
This one can help you to find some securities early while they are still at a discount price. But there is a catch. Many times the price of the security is there for a reason and some of the lower ones are there because they are seen as junk or because the company wasn’t able to manage their debts very well. You have to be careful when utilizing this kind of strategy to make sure that it will actually work for you.
The fundamental analysis can take some time to learn how to work with. There are a lot of different factors that you need to work with. You aren’t just looking through the charts of a stock or security and where it has gone in the past, even though this is important as well. But you also have to look more at the basics of the company and see how it is doing.
For example, with a fundamental analysis, you need to be able to look at the company and see how its management is doing. If there are any big changes in the management, then you have to look and see how this is going to shake up the industry and how investors are going to respond. If the change is because one of the board members just decided to retire, it isn’t a big deal. But if there were some scandals and other issues and that caused the change in the management, then this can be really difficult to work with and may show that the stock isn’t going to go up soon.
You should also look at the debt to income ratio of the company. If the company is taking on too much debt, it means that they won’t be able to pay their shareholders, and the value may go down. But the reason of the debt accumulation can matter. If the company did a recent expansion, or purchased some expensive equipment to help them grow, then this is a good thing and the price of the stock should go up shortly.
But, it can also go the other way. If the company took on too much debt because of mismanagement or they just can’t seem to make enough to pay down regular debts and the paychecks to their employees, this is going to show poorly on the company. If this is what you are seeing with the company, then it may be time to switch and look for some other securities to work with.
These are just two of the main points that you are going to need to look into when you want to do a fundamental analysis with options. It is a method that a lot of people like to use, but often it is going to be done at the same time as the fundamental analysis, rather than doing it on its own. Many traders like the fundamental analysis because it helps them to find an underlying security that is doing poorly but should turn around soon, but they still like to have some of the technical analysis in place to help them see more about the security.
Tip 12: Working with a technical analysis
For most of the strategies we will explore, you will employ a technical analysis. The technical analysis can be a great option because it relies on research of the charts and the history of a particular option. It assumes that all of the other information about the company, including its work, public perception, and anything else explored in a fundamental analysis, is already accounted for in the price.
This can make things a bit easier for you. You get the benefit of just looking at the charts for that underlying asset to make your decisions. You can look at how it has behaved in the past, and bring in current news events to see if it is likely the asset will continue on with its current trajectory or move a different way. From this information, you an pick out the right technical analysis strategy and then enter the market when you are ready.
Before using this strategy, make sure that you are ready and you fully understand the way that it should work. Have lots of charts to back you up, and some good news sources so you can pay attention to anything that may affect the current market for the options you are in.
A technical analysis is going to be a type of trading strategy that is going to evaluate the investments and then identify the trading opportunities that come with that. This is going to occur after analyzing all of the statistical trends that occur from earlier activity with that security and can include some aspects like the volume and the price movement of the security.
Unlike what we saw with the fundamental analysis, or those who like to look at the intrinsic value of the company, a technical analyst is going to focus on some of the patterns that come with price movements, trading signals, and other charting tools to help evaluate how weak or strong the security is at that particular time.
You are able to work with a technical analysis on any kind of security, as long as it has a historical type of trading data that you can look through. This means that you are able to use it with any security such as stocks, commodities, fixed income, currencies, futures, and other types of securities. All of the different strategies that we are going to talk about below will work on the idea of a technical analysis as well, which means that there are plenty of opportunities for you to utilize the tools with this method.
The technical analysis can be a really great way for you to invest and see some great results. Some of the different key takeaways that you can consider when it comes to a technical analysis includes:
- This kind of strategy is going to ask the trader to evaluate the different investments they want to work with and then identify some of the best trading opportunities in price trends and various patterns that are found on the charts.
- The analysts and traders who use this method believe that the past activity of that security, and any price changes that occur with that security, can be valuable because they indicate the price movements that security is going to see in the future.
- A technical analysis is often going to be contrasted against a fundamental analysis. Sometimes the two of these are used together to really help the trader figure out the right securities to trade in order to get a goo deal on the security, and to figure out which direction it is going to take in the future.
Tip 13: Strategies in a bullish market
Bullish strategies are going to be employed when an options trader expects that the stock price is going to move up. They can also use time decay in a comb of bulls and bears, which is known as a Calendar Spread, and not even need to rely on the movement of the stock. You also have the option of just assessing how high the price of the stock can reasonably go in a certain time frame and then optimize this by purchasing a bullish option. But with most bullish trading strategies, the trader would simply use the idea of purchasing a call option.
The stock market will always make some kind of change, either going up or down. It is up to you as the trader to figure out which strategy you should use base on how the market is doing at that particular time. Moderately bullish traders will usually set their own target price for that bull run, and then they can use a bull spread in order to reduce the potential risk, or even eliminate that risk altogether. To of the choices you can make with this are the bull put spread and the bull call spread
The bull call spread is going to occur when the trader purchase a call option that has a lower strike price. At the same time, they will sell another call option, but this one needs to have a higher strike price. Often the call with the lower price is going to be known as at the money, and then the one with the higher price is the out of the money option. Both of these securities need to have the same expiration and underlying security. The break even point on this is the lower strike price plus any premium that you paid.
Another option is the bull put spread. This is going to be constructed when you sell a higher striking in the money put options, and then you buy the same number of lower striking out of the money put options. These should have the same expiration and the same underlying security. The trader is going to use this kind of strategy in the hopes that the price of that security will go up far enough that any written put option will expire while being worthless.
You can also use mild bullish trading strategies. These are going to make money as long as the price of the underlying stock doesn’t go down by your chosen expiration date. You can also work with out of the money covered calls to help with this, but they do require that you actually purchase the stock in the end, unlike other options strategies, which is why it is known as a covered call.
Tip 14: Strategies with a bearish market
You can also work with bearish options strategies. These are used when the trader expects that the price of their underlying stock is going to move down. Before entering into the trade, it is a good idea to assess how low the price of that stock could possibly go, and how long it will take for that decline to happen. If you are a moderately bearish trader, you will most likely work with the bear put spread or the bear call spread.
First is the bear call spread. This is a limited risk and a limited profit risk options trading strategy that is used when the trader wants to be moderately bearish. You will enter into it by purchasing the call options of a specific strike price, and then you will sell the same number of call options of a lower strike price, using the same expiration and the same underlying security.
You can also work with the bear put spread. There are a few things that need to happen with this one. You can enter into this strategy by buying a higher striking in the money put options and then selling the same number of the lower put options using the same expiration and the same underlying security. With this one, the trader is hoping that the price of that asset drops, which can help them to maximize their profits.
Tip 15: The straddle and strangle strategies
These two strategies work together in a similar manner, so we are going to explore them together. A straddle is going to involve purchasing a call and a put that have the same strike price and the same expiration time. If the stock price ends up being close to the strike price when you get to the expiration of that option, then the straddle will lead you to a loss.
However, if you see a sufficiently large movement, either up or down, then there is a significant amount of profit that you can earn. This kind of strategy is going to be appropriate any time that the investor expects a bit move in the price of the stock, but the market is so volatile that they aren’t sure which way it will move.
Then there is the strangle strategy. This one is going to allow you to make a profit based on how much the price of your chosen security moves, with very little exposure to the direction of that price movement. If you purchase the option, it is known as a long strangle but if you sell the options it is a short strangle. The big difference between the strangle and the straddle is that it give you a choice of balancing the cost of opening a strangle versus how profitable it can be.
Both of these can be nice strategies to go with because they limit the amount of risk that you take, but there is the potential for unlimited amounts of profit. If the movements don’t happen, then you aren’t going to be able to earn any profits and you will take a loss. But if the movements do happen, no matter which direction they go, you will stand to earn a lot of profits in the process.
Tip 16: The Iron butterfly and the iron condor strategies
The iron butterfly, which can often be referred to as the ironfly, is a neutral looking trading strategy that will involve buying and holding four options at the same time, with three different prices. It is a limited risk, but also limited profit, trading strategy and it is structed for a larger profitability of earning if it is done in the proper way, with a smaller limited profit if the stock that you choose to work with is seen to be low volatility.
You can also work with the iron condor if you choose. This is when you simultaneously purchase a put spread as well as a call spread. Both of these need to come in with the same expiration, but there should be four different strike prices present. In some cases, the iron condor is going to be seen as selling a strangle instead of buying, and it can also limit some of the risk that you take in on both the put side and the call side. This helps you to build a bear call vertical spread and a bull put vertical spread in the process.
Tip 17: Other non-directional or neutral strategies
So far we have talked about a lot of different options trading strategies. But there are still so many more that you can choose to work with. Knowing how to make several of these work at a time can be helpful because it sets you up to seeing success no matter how the market is doing at the time. Some of the different strategies that you can work with here include:
Guts: You will need to buy, the long gut, or sell, the short gut, a pair of in the money call and puts for this one.
Butterfly: This one is seen as a neutral strategy where you will combine together the bear and the bull spreads. The long butterfly spreads are going to have four option contracts open at the same time with the same expiration dates, but there will be three strike prices. This can provide you with a range of prices that the strategy could potentially profit from.
Risk reversal: This is going to be one that will simulate the motion of an underlying asset. They are sometimes known as a synthetic short or long position, based on the specific position that you short.
Collar: For this one, you will purchase the underlying asset and then purchase a put option, at the same time, below the current price of it. Then you would also sell a call option that is higher than the current price.
Fence: Here you are going to purchase the underlying asset and then also, at the same time, buy the options either side of the price. This can help to limit the range of possible returns.
Jade Lizard: This is a type of bull vertical spread that is going to be created when you use some call options. It has an addition of a put option that you sell at the strike price lower than the strike prices of the call spread with the same expiration.
Tip 18: Learn how to work with options spreads
Options spreads are going to be the building blocks of any kind of trade you decide to do. The spread position will be entered when you purchase and sell an equal number of options from the same class, on the same underlying security. But there are going to be different expiration dates and strike prices along the way.
There are there types of these spreads known as the diagonal spread, the vertical spread, and the horizontal spread. They will be grouped based on the relationship that is there between the expiration dates and the strike price of any options you involve in the trade. The differences between these options spreads include:
- Vertical spread: These are also known as money spreads. They are ones that involve options that have the same expiration month and the same underlying security involved in both options. But the strike price on each one is going to be different.
- Horizontal spreads: These are also known as calendar spreads or time spreads. They are going to be created when the trader uses options that have the same strike prices and the same security with them. But the difference is going to be the expiration dates.
- Diagonal spreads: These are going to be when you use options that rely on the same underlying security. But you will use different expiration dates and different strike prices. These are often a combination of the horizontal and the vertical spreads, which is what gives them their name.
Basically, with the spreads, you are going to purchase the option twice, but it will have either a different strike price or a different expiration date, or both, depending on how the market goes. This helps you to limit your risks and ensures that you are able to get some profits, especially in a market that is too volatile to pick just one direction.
One of the most important things that you can do when it comes to trading in options is to pick out the strategy that works the best for you. There are a variety of strategies out there, and knowing the one that works for you and making adjustments based on how the market behaves can make a world of different on how much you can earn in the process.
