Options Trading

Options trading can quickly become very complicated. There are LEAPS (long-term contracts), choosers, barriers, compounds (exotics) and a host of technical parameters to measure volatility and predict price movements.

Some of these options trading complications can be simplified into a number of simpler options trading strategies. Most revolve around using the fact that options have a contractually specified expiration date and strike price. This makes options trading subject to some techniques not available in regular stock investing.

Calendar

The 'calendar spread' or 'time spread' options trading strategy involves simultaneously buying and selling two options of the same type, with the same strike price, but different expiration dates.

For example, purchase two calls of HD (Home Depot) at a strike price of $35, but one set to expire in April, the other in June. The idea of this options trading strategy is to attempt to gain from the difference in price, due to time decay, as each contract advances toward expiration.

Straddle

In a 'straddle' options trading strategy the investor holds both a call and a put, on the same underlying asset, with the same strike price and expiration date. This options trading strategy is also termed delta neutral trading.

This options trading strategy seems like betting against oneself. No matter which way the price goes the trader loses. But, it's also true that no matter which way the price goes the trader gains.

It's this feature that makes the straddle options trading strategy a kind of hedging strategy. Since price direction and amount can only be predicted to some degree of probability, the options trading investor is 'hedging his bets'.

While risky, this options trading strategy can produce profits when price movements are large in any direction. The chance to realize profit is increased by limiting trades to stocks with cheap options.

Strangle

Yet another variation is the 'strangle' options trading strategy. The trader holds both call and put options with the same maturity, but with different strike prices.

These options are purchased 'out of the money' and therefore cost less to buy. 'Out of the money' means the strike price of the underlying asset is – higher (for a call) or lower (for a put) – than the market price.

Suppose Home Depot (HD) is currently trading at $35 per share. Buy one call at $3 and one put at $2 with the call having a strike price of $40, the put $30. (Total Investment = ($3 x 100) + ($2 x 100) = $500.)

Strangle options trading requires larger price movements in the underlying asset. In the example, if the price over the length of the contracts stays between $30 and $40 the total possible loss = $500, the cost of the options.

Suppose the price drops to $20. The call is worthless, but the put is worth ($30-$20) x 100 = $1000 - ($2 x 100) = $800. Subtract the cost of the call, $800 - $300 = $500. This represents the net profit (ignoring commissions and taxes) on the trades.

Options trading can be a challenge in the form of following carefully the movements of both the options and the underlying assets. Step up to this challenge and realize the profits available in options trading.