6 strategies for option trading everyone should know

The right options trading strategies can boost your earnings significantly with fairly minimal upfront investment, although there’s risk involved. Not sure how to get started? Let’s walk through 6 popular strategies for option trading along with the possible outcomes of each.

6 popular strategies for option trading

1. Covered call strategy
2. Bull call spread strategy
3. Bear put spread strategy
4. Protective put (married put) strategy
5. Long straddle strategy
6. Protective collar strategy

1. Covered call strategy

The covered call strategy involves selling call options on stock you own. If the stock doesn’t reach the strike price, you profit from keeping the option contract fees. But you have to sell your stock if the strike price is reached and the buyer decides to buy.

The covered call strategy is most successful when the stock price rises but does not reach the strike price, leaving you with fees for a contract the buyer cannot exercise and stock you can sell at a higher price.

How to use the covered call strategy

1. Buy stock. Options contracts are typically bought in multiples of 100, so you don’t have to buy if you already own 100+ stocks.
2. Sell call options. Selling a call option means you give a buyer the right to buy your stock at a specific price by a specific date (but the buyer may choose not to do so).
3. Collect the contract fee. Collect the option contract fee from the buyer. To increase your odds of keeping both the contract fees and your stock, select an contract expiration date at least 1 month in the future.

Strategies for option trading: Covered call example

Say you own 100 Apple stocks, and the current market price is $150. Sell a call option for $2 per stock with a strike price of $170 and an expiration date of 1 month later. You get $200 (100 stocks X $2 per contract).

3 possible outcomes:

1. Stock doesn’t reach the strike price by the expiration date. The options expire worthless, and you keep the $200 contract fee and your 100 stocks.
2. Stock rises, but doesn’t reach the strike price. You buy back the option for, say, $1 per stock ($100 total) and keep your stock. You profit $100 ($200 option contract fee – $100 paid to buy back the option) and can now sell another covered call and repeat the process.
3. Stock reaches the strike price. The buyer exercises the option to buy. You sell your 100 shares at $170 per share.

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2. Bull call spread strategy

The bull call spread strategy involves placing 2 orders (known as “legs”) at the same time: Buy a call option with a low strike price, and sell a call option for the same stock with a higher strike price. The lower and higher strike prices create a range in which you can profit, although your profit is limited by the higher strike price.

Use the bull call spread strategy when you expect a stock’s value to experience limited or modest gains.

How to use the bull call spread strategy

1. Find a stock you think will rise in value.
2. Open a spread order. Buy a call option at one strike price, and add another leg by selling a call option at a higher strike price. Set the same expiration date for both contracts.
3. Exercise both orders if the market price reaches the higher strike price. Your profit comes from buying the stock at the lower strike price and selling it at the higher strike price.

Strategies for option trading: Bull call spread example

You want to buy Apple stock, because you think the price will rise. You open a spread order (a combination of 2 orders or positions) where you buy 1 call option for $2 that gives you the right to buy 100 Apple stocks at a $150 strike price.

You also sell a call option for $1 giving a buyer the right to buy 100 Apple stocks at $155. The fee from selling a call option helps minimize the overall cost of this strategy.

2 possible outcomes:

1. Stock price goes up. The price reaches the first option strike price of $150. This won’t trigger your trade if you entered the position as a spread. If the market price reaches the strike price by the expiration date, you buy 100 stocks for $150 each and sell those stocks for $155 each, profiting $5 per stock (for a total of $500) minus the net options contracts fees.
2. Stock price goes down. Neither options contract is exercised. You only lose the buy call option fee you paid minus the sell call option fee you earned.

3. Bear put spread strategy

Also known as a debit put spread or a long put spread, the bear put spread strategy involves placing 2 orders at the same time: Buy a put option with a high strike price, and sell a put option for the same stock with a lower strike price.

The fee you earn from selling a put option helps offset what you pay to buy the put option, making this strategy less expensive than simply buying a put option.

The bear put spread works just like the bull call spread, except you profit if the stock price drops. This strategy is useful when you expect a stock to experience moderate to large losses.

How to use the bear put spread strategy

1. Find a stock you think will rise in value.
2. Open a spread order. Buy a put option at a high strike price, and sell a put option at a lower strike price. Set the same expiration date for both contracts.
3. Exercise both orders if the market price falls below the lower strike price. Your profit is the difference between what you make selling stock at the higher strike price and what you make selling stock at the lower strike price.

Strategies for option trading: Bear put spread example

You suspect the price of Apple stock will lower and want to profit off the prediction. You open a spread order (a combination of 2 orders or positions) where you buy 1 put option that gives you the right to sell 100 Apple stocks at a $150 strike price.

You also sell a put option that gives you the right to buy back 100 Apple stocks at a $145 strike price. You pay a fee to buy the put options, By selling put options, you earn back some of what you spent to buy put options.

Note: You don’t need to own Apple stocks to exercise a put order (the right to sell). You just need enough money to exercise the trade. Your broker will hold your funds as collateral until the options contracts are exercised.

2 possible outcomes:

1. Stock price goes down. This is ideal. Say Apple’s stock price is now $140. You sell Apple stocks at the $150 strike price and buy the stocks back at the second strike price of $145, pocketing the difference minus the contract fees.
2. Stock price goes up. Your options contracts aren’t exercised and expire as worthless. You’ve only lost the premium you paid to buy the put options contract.

4. Protective put (married put) strategy

The protective put strategy, also known as the married put strategy, involves buying put options giving you the right to sell shares you own if the strike price is reached. This strategy is useful as an insurance policy, limiting your losses if a stock doesn’t perform as well as you think it will.

Protective put vs. Stop-loss order

A stop-loss order is exercised as soon as the strike price is reached, regardless of whether a more favourable price is reached afterwards. With a protective put, you have the option to exercise a trade until the expiration date, giving you the chance to trade when the strike price is reached or wait to see if the price moves in a more favourable direction.

How to use the protective put strategy

1. Buy stock. Options contracts are typically bought in multiples of 100, so you don’t have to buy if you already own 100+ stocks.
2. Buy a put option. This gives you the right, but not the obligation, to sell your stock at a certain price. The strike price should be set at a point where you’re comfortable taking a loss.
3. Exercise your option if the strike price is reached. If your stock goes down in value, selling can limit your losses.

Strategies for option trading: Protective put example

Say you have 100 Apple stocks currently valued at $150. The market suddenly takes a downturn, and you’re worried your stock will be affected. You buy 1 put option for $2 per stock ($2 x 100 shares = $200) with a strike price of $140, giving you the right the sell if the stock price falls to $140.

2 possible outcomes:

1. Stock price rises (you were wrong). Against your expectations, the stock rises to $200. Your option expires worthless, and you lose the contract fee of $200. However, this is offset by gains from the stock price rising.
2. Stock price goes down beyond the strike price (you were right). As expected, the stock price falls to $120. You exercise your option and sell for $140 per stock. You lose the contract fee you paid ($200), but if you hadn’t bought an option, you would have lost $20 per stock ($2,000 total).

5. Long straddle strategy

The long straddle strategy involves buying a long call option and a long put option on the same stock with the same strike price and expiration date. This gives you the right to buy and sell the stock if the strike price is reached.

This strategy is useful when you think a stock’s price will strongly change based on market-influencing factors (such as earnings reports or legislative changes), but you aren’t sure whether the price will go up or down.

To profit, the stock price needs to change in value enough to exceed the cost of buying both types of options. So, the long straddle strategy isn’t suitable unless you anticipate the stock price will change significantly.

How to use the long straddle strategy

1. Buy a call (right to buy) option. The strike price should be “at the money” (current market price) or as close to it as possible.
2. Buy a put (right to sell) option for the same stock. Set the same strike price and expiration date as the call option.
3. Exercise your option if the stock price changes. If the stock price goes up, exercise your call option to buy the stock at a lower price than it’s worth. If the stock price goes down, exercise your put option to sell stock at a higher price than it’s worth.

Strategies for option trading: Long straddle example

You buy a $2 call option on Apple stock with a strike price of $150, giving you the right to buy 100 Apple stocks at this price. In addition, you buy a $2 put option on Apple stock with a strike price of $150 and the same expiration date. This gives you the right to sell 100 Apple stocks at $150.

2 possible outcomes:

1. Stock price goes down. The price drops to $120. You exercise your put option and sell 100 stocks at the strike price of $150. Your call option, or the right to buy Apple stocks, expires worthless. Your only cost is the total fee you paid to buy both the call and put contracts ($4 per stock).
2. Stock price goes up. By the expiration date, the stock price rises to $170. You exercise your call option to buy 100 Apple stocks at $150. Your cost is also the total fee you paid for both the call and put contracts ($4 per stock).

6. Protective collar strategy

The protective collar strategy involves buying a put option (right to buy) with a strike price below the current market price and selling a call option (obligation to sell) with a strike price above the current market price. The fee earned from selling the call option helps offset the cost of buying the put option.

This strategy aims to protect your stock from potential short-term losses. It’s suitable if you’re unsure which direction a stock is going to move.

Protective collar vs. Bull call spread

With the protective collar strategy, you buy a put option and sell a call option. With the bull call spread strategy, you buy a call option and sell a call option.

You profit from a bull call spread if the stock price rises. But if it drops, neither option you purchased is exercised, and you only lose the options contract fees you paid. The bull call spread is suitable if you expect a stock to experience modest gains.

The protective collar strategy is also profitable if the stock price rises. But if it drops, you’re forced to sell at a loss, although the loss is limited by the fact that the strike price is higher than the market price. The protective collar is suitable if you aren’t sure how a stock is going to move, and you want to guard against losses.

How to use the protective collar strategy

1. Buy stock. Options contracts are typically bought in multiples of 100, so you don’t have to buy if you already own 100+ stocks.
2. Buy a put option. Set the strike price below the current market price. If the stock price goes lower than the strike price, you can limit losses by selling at the strike price.
3. Sell a call option. The strike price should be above the current market price, and the expiration date should be the same as the put option you bought. You’ll be obligated to sell if the strike price is reached.

Strategies for option trading: Protective collar options example

You buy 100 Apple stocks for $140 each. Later, you buy a $2 put option with a strike price of $135, giving you the right to sell at $135 if the stock price tanks. The cost is $200 ($2 contract fee X 100 stocks).

You simultaneously sell a $1.50 call option with a strike price of $150, giving you the right to sell if the price reaches $150. You earn $150 from this transaction ($1.50 contract fee X 100 stocks).

2 possible outcomes:

1. Stock price goes down. The price drops to $120. You exercise your option to sell at $135, limiting your losses to $500 (100 stocks X $5 difference between the purchase and sale price) instead of $2,000 (100 stocks X $20 difference between the purchase and sale price).
2. Stock price goes up. By the expiration date, the stock price rises to $160. You sell your stocks at $150, earning $10 more than you paid to buy each stock. Your cost is $50 ($200 paid to buy put options minus $150 collected for selling call options).

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How to decide which of these options trading strategies is right for you

There are many options strategies, only some of which are covered in this guide. Here are some tips for figuring out which strategy could be useful for you:

• Covered call strategy: Use when you don’t expect a stock’s price to change much in the next little while and intend to hold on to your stock for a while.
• Bull call spread strategy: Use when you expect a stock’s value to experience limited or modest gains.
• Bear put spread strategy: Use when you expect a stock to experience moderate to large losses.
• Protective put (married put) strategy: Useful for limiting your losses if a stock doesn’t perform as you expect.
• Long straddle strategy: Useful when you think a stock’s price will change a lot based on market-influencing factors, but you aren’t sure whether it’ll go up or down.
• Protective collar strategy: Helps protect your stock from potential short-term losses if you’re unsure which direction a stock is going to move.

Frequently asked questions about options strategies

• What is options trading?

  An option is a financial derivative, which means you don't trade a security directly. Instead, you trade the right (but not obligation) to buy or sell a security at a specific price by a specific date (called the "expiration date"). The terms of the transaction are laid out in a contract agreed upon by the buyer and seller.

• What is the best strategy for options trading?

  The best strategy for options trading depends on your level of confidence in how a stock's price will move in the short or long run, whether you think it'll move a little or a lot, how much you prioritize preventing loss, the degree to which the market is volatile/predictable and other factors.

  If you aren't reasonably confident of how a stock will move and/or can't afford to take a loss, you should consider a less risky investment strategy.

• What is the safest option strategy?

  The covered call strategy is considered by many to be one of the safest options strategies, because it requires that you actually own stock and you can earn money from selling call options. But there's still risk involved, as the value of your stocks could go down.

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Kliment Dukovski

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Kliment Dukovski was a personal finance writer at Finder, specializing in investments and cryptocurrency. He's written more than 700 articles to help readers compare the best trading platforms, understand complex investment terms and find the best credit cards for their needs. His expert commentary has been featured in such digital publications as Fox Business, MSN Money and MediaFeed. He’s also well-versed in money transfers, home loans and more — breaking down these topics into simple concepts anyone can understand. In another life, Kliment ghostwrote guides and articles on foreign exchange, stock market trading and cryptocurrencies. See full bio

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