Top Options Trading Strategies Every Trader Should Know

Options trading offers a versatile toolkit for capitalising on market movements, hedging positions, or generating income. Understanding and implementing effective options trading strategies can significantly enhance a trader's ability to manage risk and optimise returns.

Below, we delve into some of the most widely used options trading strategies that every trader should know.

10 Options Trading Strategies for Consistent Profit

1) Long Call

The long call strategy is one of the simplest and most popular options trading techniques for bullish traders. In this strategy, a trader purchases a call option, expecting the underlying asset's price to rise significantly above the strike price before the option expires. The potential profit is theoretically unlimited as the asset's price rises, while the maximum loss is limited to the premium paid for the option.

Long calls are typically used when a trader is confident in a stock's upward momentum but wants to limit downside risk. This strategy also allows for leveraging market positions, as buying a call option is often cheaper than purchasing the actual stock.

2) Long Put

Conversely, traders who expect a decline in the price of the underlying asset favour the long-put strategy. In this strategy, the trader buys a put option, giving them the right to sell the asset at the strike price. If the asset's price falls below the strike price, the trader can either sell the option for a profit or exercise it to sell the asset at a higher price than its current market value.

Like the long call, the loss is limited to the premium paid, while the profit potential increases as the asset's price decreases. Long puts are often used to hedge long equity positions or to speculate on a downtrend without short selling.

3) Covered Call

The covered call strategy involves holding a long position in an asset while simultaneously selling call options on the same asset. This approach is typically employed when a trader has a neutral to slightly bullish outlook on the underlying asset. The trader collects a premium by selling the call option, which provides some downside protection and generates income.

However, if the asset's price exceeds the strike price of the sold call, the trader may have to sell the asset at the strike price, potentially capping the upside gain.

4) Protective Put

A protective put strategy entails purchasing a put option for an asset the trader already owns. This method serves as insurance against a decline in the asset's price. If the asset's price falls below the put option strike price, the trader can exercise the option to sell the asset at the strike price, thereby limiting potential losses.

This strategy is especially effective in volatile markets where downside protection is desired.

5) Bull Call Spread

The bull call spread strategy involves buying a call option at a lower strike price while simultaneously selling another call option at a higher strike price, both with the same expiration date. This approach is used when anticipating a moderate increase in the asset's price,

The premium from selling the higher strike call helps offset the cost of purchasing the lower strike call, reducing the overall investment. However, the potential profit is limited to the difference between the two strike prices minus the net premium paid.

6) Bear Put Spread

In a bear put spread strategy, a trader buys a put option at a higher strike price and sells another put option at a lower strike price, both with the same expiration date. This strategy is employed when expecting a moderate decline in the asset's price.

The premium received from selling the lower strike put reduces the cost of the higher strike put, making the strategy more cost-effective. The maximum profit is achieved if the asset's price falls below the lower strike price, while the maximum loss is limited to the net premium paid.

7) Straddle

The long straddle strategy involves purchasing both a call and a put option with the same strike price and expiration date. This approach is suitable when a significant price movement is anticipated, but the direction is uncertain.

If the asset's price moves substantially in either direction, one of the options will become profitable, potentially offsetting the cost of both options. However, if the price remains relatively stable, both options may expire worthless, resulting in a loss equal to the total premiums paid.

8) Strangle

The strangle strategy involves buying a call and a put option with the same expiration date but different strike prices. Typically, the call option has a higher strike price, and the put option has a lower strike price, both out-of-the-money. This strategy is employed when a trader expects high volatility but is unsure of the direction of the price movement.

The idea is to profit from a significant move in either direction, making one of the options valuable enough to more than offset the cost of both. The strangle is cheaper than a straddle because both options are out-of-the-money but require a larger price movement to become profitable.

9) Iron Condor

The iron condor strategy combines a bear call spread and a bull put spread, creating a position with four options contracts at different strike prices but the same expiration date. This strategy is used when a trader expects low volatility and anticipates the asset's price will remain within a specific range.

The maximum profit is achieved when the asset's price stays between the middle strike prices, while the maximum loss occurs if the price moves beyond the outer strike prices. The iron condor offers limited risk and reward, making it a popular choice for range-bound markets.

10) Iron Butterfly

The iron butterfly strategy combines a bull put spread and a bear call spread using the same strike price for the short call and put and different strike prices for the long call and put. This creates a "wings" formation around the central strike price.

The trader profits if the underlying asset stays close to this middle strike price, as all options may expire worthless, allowing the trader to collect the net premium. The Iron Butterfly is ideal for range-bound markets with low volatility expectations. It provides limited risk and profit, offering a high probability of a small gain if the price doesn't move much.

Conclusion

In conclusion, mastering these top options trading strategies can significantly enhance a trader's ability to navigate various market conditions.

As always, continuous learning and practice are essential to effectively implement these strategies and achieve long-term success in options trading.

Disclaimer: This material is for general information purposes only and is not intended as (and should not be considered to be) financial, investment or other advice on which reliance should be placed. No opinion given in the material constitutes a recommendation by EBC or the author that any particular investment, security, transaction or investment strategy is suitable for any specific person.