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Why Options Strategies are Important

Why Options Strategies are Important

Deepak Sharma 31 Jul 2020

Options strategies are conditional contracts that allow option holders to buy or sell at a chosen price. Buyers are charged an amount by the sellers for such a right. Should market prices be unfavorable for option holders, they will let the option expire worthlessly.

Now if you are asking in a simple line, What is Option Strategy

I can say Options strategies is the technical analysis study of price, volume, and open interest data to initiate trade based on the anticipation of the price movement 

Note: Derivatives are weapons of mass destruction unless handled with care. Derivatives are highly leveraged instruments hence one needs to be disciplined and robotic in trading. There should not be any emotions involved while trading. Money management and Risk Management are key to success. There is 20% logic which is the study of price, volume, open interest data whereas 80% is psychology which plays an important role in trading.

 

Key Points of Options strategies before entering Option Trade:

  1. What is your Technical Anticipation of the price movement?

  2. Which Strike price you need to select?

  3. When to initiate buying/writing Options?

First and foremost important point while trading options, it is the spot price that moves hence it is very important that you follow technical chart patterns according to spot price which is the study of price and volume data. Further while trading options as a derivative strategy analyst the study of open interest in futures gives you the analysis of what is currently happening in the market whether there is long/short build-up or long/short unwinding. After the interpretation of futures, one needs to analyze option chains and see the open interest and it can give you a very clear indication of whether the price movement will be swift or not.

For stocks that consolidate and move very slowly, it is prudent to do the writing by selling options. When you are buying options then you need to ensure that the price should move in your favor very fast as there would be a time decay. 

Few important points for stock selection in Options strategies :

  • The security needs to be highly liquid in options

  • Time decay favors the writer/seller of the options

  • Volatility is a double-edged sword if it increases after you have entered into the trade then it will be an icing on the cake or else if it decreases then it will take away a few gain points.

  • When you buy options then you should trade in those stocks which either give the target or stop loss very fast. The stocks which consolidate it would be advisable to write options.

 

Strategies used while trading options:

Covered Call /Covered Put –

With these calls, there is one simple strategy is to buy an option. You can also structure as a basic covered call. This is a very popular strategy these days because it will generate your income and reduce your risk of being long on the stock alone. The trade-off is that you must be willing to sell your shares at a set price at the short strike price.

If you are going to execute this strategy as you purchased stock as you normally can, and simultaneously write or sell a call option on those same shares.

In General, you can say It helps you to generate additional income and limited loss protection

Synthetic Call/Put –  ASynthetic Call/Put strategy is generally used by traders and they are currently holding an asset that is underlying and Bullish on it for the long term. But he would be worried about the risks which are downside in the future. This strategy offers unlimited income potential with limited risk. The strategy is used by buying put options of the underlying if you are holding this for long. This strategy can be used to lock profit while profit riding in your Futures position. 

Spread Strategies

A Spread strategy involves a position in one or more options so that the cost of buying an option is funded entirely or in part by selling another option in the same underlying. 

 

Bull/Bear Call Put Spread – 

Bull call spreads can be implemented by buying an at-the-money call option while simultaneously writing a higher striking out-of-the-money call option of the same underlying security and the same expiration month. On the other side Bear call, spreads can be implemented by buying call options of a certain strike price and selling the same number of call options of lower strike price on the same underlying security expiring in the same month.

Both calls put spread would be at low-risk strategy with limited profit/limited loss. Further when to deploy straight Buying ATM/Selling OTM or Reverse Selling ATM/Buying OTM would depend on your anticipation of the price based on intraday/weekly options/monthly options, price target, and technical chart moving average.

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