Four Strategies for Options Trading Experienced Investors Should Consider

When you buy a home, drive a car, or contemplate important health issues, insurance is nothing short of a must.

Sure, you pay a premium to protect yourself against risks like car accidents or pricey health problems. But that premium also affords you the right to protect yourself with a claim if a dark day occurs.

Options trading is basically an insurance policy for your investments. But instead of insuring your car or health, you're making sure your stock, currency, commodities, or other investment purchases receive extra protection.

And once you get a feel for options trading, once calls and puts start becoming second nature, a new, deeper understanding of options contracts can lead toward even more advanced options strategies.

1. Long Straddle

If you think an asset is ready for significant price movement, but you aren’t sure which direction its value will ultimately go, you can put yourself in a long straddle to benefit from either outcome.

For example, you could buy both call and put options on Alpha Co. stock if you believe its value is about to see a shift. If your strike price is $50 per share and an option contract is $3, you might buy both one-month call and put options on Alpha simultaneously at a cost of $6.

As you watch Alpha stock over the next 30 days, you’re banking only on the stock’s volatility, so strong upward or downward surges are both positive outcomes for you.

If the stock rises to $60, you exercise your call option to buy at $50, then immediately sell it at its current $60 market rate. You’d earn $4 per contract ($50 - $40 - $6 contract and premium costs) and let the put option lapse.

If the stock sinks to $40, this time you’d use the put option to sell shares at the $50 strike price, then buy them at the $40 market price. Again, you’d make a $4 per contract profit.

“Remember that the three basic factors of options are direction, duration, and magnitude. A long straddle is when you have conviction on magnitude and duration, but not direction,” longtime options expert and OpTech UK CEO Paul Anderson said. “You can be correct if the stock goes up or down. You just need to know by how much and when it will happen.”

“It has an easy break-even, and you have to move more than you pay for the straddle. So, risk is defined to premium and the potential is unlimited.”

2. Bull Call Spread

You may be feeling moderately bullish about a stock and convinced its value is on the rise. However, you’d still like to temper your optimism by limiting your upfront costs as well as any potential losses. A bull call spread, also known as a basic call spread, can help offer that protection.

If you think Beta Company is a moderate winner at $50 per share over the next three months, then you might enact a bull call spread by making a pair of transactions. First, you buy a call option with a $55 strike price at $3 per share as your long call for the three-month period. That’d be a net cost of $300 to you, but you’d make back $100 immediately on your corresponding short call of Beta stock, selling a call option at a strike price of $60 for $1 per share.

If Beta rises to over $58 (your $55 strike price plus the $3 premium) a share, then your long call option makes you money. While your short call caps your profit potential with its $60 strike price, your long call sale would still net you nearly $500 on 100 shares, even after covering your initial $200 cost.

If Beta never reaches $58, or even if it sinks below $53, you can allow both your short and long calls to expire and only be out your initial $200 investment.

3. Bear Put Spread

How about if you think a company stock will sink over the next three months? The spread strategy still works, but this time, using a bear put spread model.

If you think Gamma Company at $60 per share will see losses within three months, you’d perform another pair of affiliated moves: buying a long-put option with a $55 strike price at $3 per share, while selling a short put option with a $50 strike price at $1 per share.

If Gamma eventually falls under the $58 strike price, you’d see similar gains to the call spread scenario, bringing in a nearly $500 profit after your $200 initial cost.

And once again, you’re protected. The spread makes sure you’d only be out that initial $200 investment if contracts expire without Gamma falling under $53 per share, or even if it increased.

4. Collar Strategy

If you’re more cautious when it comes to risk, the collar strategy should grab your interest. It allows long-term investors to put added downside protection in place on options contracts while still generating profit from call option sales. With this approach, you can better shield long-term portfolio assets against potential price downturns.

Say you already own 100 shares of Delta Co. stock at $60 per share. Under the collar strategy, you’d buy a three-month protective put option with a strike price of $55, costing you $3 for the contract. You’d also sell a three-month covered call option at a $65 strike price, making $2 per contract.

With the protective put costing you $300 and the covered call making you $200, the net cost of the collar would be $100.

With the collar in place, you’re partially protected should the Delta stock value fall. If it moves below $55, you can sell your shares at $55, limiting your potential loss. Of course, this strategy also caps potential profits by forcing you to sell those shares if they rise over the $65 strike price.

Meanwhile, you also receive almost $200 in call option income to help offset the $100 net cost of the collar itself.

With the collar strategy, Anderson feels conservative investors can prioritize capital preservation over chasing unlimited profit potential.

“This is a great trade to let you sleep at night,” Anderson said. “You sell some of the upside potential of your stock and use the money collected to buy some protection to the downside. It spreads your stock positions around and is a great early use of options. One of the mottos I like is, staying spread is staying alive.”

From flexibility to hedging to risk management, trying multiple options strategies can offer significant advantages. Armed with that practical experience, investors can tailor their options trades to best fit their specific financial goals and risk tolerance.

Hear more from Paul Anderson about options trading during his appearance on the Axos Investing Evolved podcast.

Investors can place commission-free stock, ETF, and mutual fund trades through Axos Invest from any device, anytime. Get started with your new Self-Directed Trading portfolio today.