Options help you trade with the flexibility of positioning your trades for all market conditions—bullish, bearish and even sideways. The only caveat is choosing your options strategies intelligently.
In case that brings about a question to your mind as to what the different options strategies are…fret not. In this article, we’ll be discussing some of the most popular options trading strategies. However, before we jump into strategy if you’d like to brush up on a few F&O fundamentals...
Check out our article: 18 Terms to Remember for Futures & Options Traders
Ready, let’s begin!
1. Covered call—a long stock position and a short call position
A Covered call has two legs—buying a stock and selling a call with a higher strike price. Traders employ this strategy when they have a neutral-to-bullish view of the stock yet they want to limit their risk.
For instance, say you bought 250 shares of Reliance Industries at Rs 2,760 and sold a Rs 2,800 call at Rs 29.
Under this strategy you are betting on time decay, i.e. you don’t expect prices to rise above Rs 2,800 so that you can keep the option premium and profit from your spot position. Conversely, a loss can occur if spot prices fall below the break-even point i.e. Rs 2,731.
2. Protective (Married) Put—a long stock position and a long put position
If your long-term view on the stock is bullish but you don’t rule out the possibility of a fall in the short term, then a Protective Put or Married Put is a strategy to opt for.
The Protective Put involves buying a stock and also simultaneously buying an at-the-money put option. Let’s assume that you are buying 250 shares of Reliance Industries at Rs 2,760. You may also buy an at-the-money put option at Rs 35. In this case, you anticipate spot prices to rise above Rs 2,795. The intent is to keep the upside potential of the stock yet opt for protection against an even-specific short-term downside risk.
3. Long —a long position call and a long position put with the same strike price
Long Straddle involves buying a call as well as a put option for the same stock, at the same strike price and the same expiry.
Eg: You may buy a call for Reliance at Rs 45 and buy a put at Rs 35 with a strike price of Rs 2,760. By initiating these positions, you will incur an upfront cost equivalent to the option premium. Since your net cost is Rs 80, your profit will start above Rs 2,840 or below Rs 2,680.
An options trader employing the Long Straddle strategy hopes to see a quick stock price movement in any direction; therefore, the primary bet is on volatility and not on mere a price change. This strategy could be useful to safeguard against news-driven volatility—earnings announcements, policy announcements, market data announcements, etc.
4. Long Strangle—a long call and long put at different strike prices
While Long Strangle may seem a similar strategy to Long Straddle, strike prices of underlying options can make a considerable difference to the actual premium outgo.
Eg: You may buy a call option of Reliance with a strike price of Rs 2,780 and a put option with a strike price of Rs 2,740 when the prevailing market price is Rs 2,760. This results in a premium payment of Rs 36 and Rs 27 on the call and the put option respectively.
In this case, your profit will start either above Rs 2,843 (Rs 2780+ total premium of Rs 63) or below Rs 2,677. Long Strangle often appeals to options traders due to their lower upfront costs (as compared to Long Straddle). However, it should be noted that their break-even points are farther, and thus they rely on a massive rise in volatility in a short span of time.
5. Short Straddle—a short call and a short put at the same strike price
Short Straddles involve options traders writing a call as well as put option for the same stock, at the same strike price and the same expiry.
Eg: By selling a Reliance call for Rs 2,760 and a put option at Rs 45 and Rs 35 respectively, you may have an upfront earning of Rs 80. However, that becomes your maximum potential profit, while your loss potential is unlimited above Rs 2,840 and below Rs 2,680. If a trader going for Long Straddle expects volatility, one who uses Short Straddle bets on a range-bound movement.
6. Short Strangle—a short call and a short put with different strike prices
The opposite of the Long Strangle. Traders employing the Short Strangle strategy expect a range-bound movement with little or low volatility. They collect an upfront option premium by selling a call with a higher strike price and a put with a lower strike price. For instance, by selling a call for Reliance at Rs 2,780 and a put for Rs 2,740 at Rs 36 and Rs 27 respectively, a trader can earn eke out a profit, the caveat being that prices not shifting above or below Rs 2,843 and 2,677.
7. Bull Call Spread: A simultaneous long and a short call
This strategy involves buying a call with a low strike price and selling a call with a higher strike price for the same expiry. This strategy generally works under gradually rising market conditions wherein the downside is protected.
For instance, if you buy a 2,760 Reliance call at Rs 45 and sold a 2,780 Reliance call at Rs 36, it results in a net outflow of Rs 9. In this case, the breakeven point would be Rs 2,769 (lower strike price increased by the net premium outflow). The maximum profit potential of this trade would be Rs 11 i.e. the difference between two strikes adjusted for the net premium outflows.
8. Bear Put Spread: A short put and a long put
This strategy is useful under gradually declining market conditions. As part of the Bear Put Spread strategy, traders go for a long put position with a higher strike price and a short put position with a lower strike price, simultaneously. For instance, if you expect a gentle price decline during the current month's expiry, you may buy a 2,780 Reliance put at Rs 46 and sell a put with a strike price of Rs 2,760 at Rs 35. This will create a net debit position of Rs 11 which would be your maximum potential loss. While your maximum profit will be capped at Rs 9 (the difference between two strike prices less net debit on account of premiums).
9. Bear call spread—Selling a call with a lower strike and buying a call with a higher strike
Continuing with the example discussed in the bull call spread strategy, here you would sell a 2,760 Reliance call at Rs 45 and buy a 2,780 Reliance call at 36. For this strategy, the maximum profit potential would be Rs 9, i.e. the net of the premium paid and received. And the maximum possible loss is capped at Rs 11 i.e. the difference between spreads adjusted for the net inflow of options premium.
10. Bull Put Spread—Selling a put with a higher strike and buying a put with a lower strike
This strategy is suitable for neutral to moderately bullish market conditions. For instance, you may sell a 2,780 Reliance put at Rs 46 and buy a 2,760 Reliance put at Rs 35. This will result in a net credit position of Rs 11, your maximum potential profit. As you must have guessed, the maximum loss is the spread minus your net credit premium. In other words, the maximum loss potential of this strategy is Rs 9.
11. Long Butterfly Spread—Two long calls and two short calls
This is an advanced strategy to profit from a low-volatility environment. In the Long Butterfly spread you select three strike prices, buying two calls and selling two calls creating a predictable maximum profit and a maximum loss trade-off.
For example, you may sell two 2,760 Reliance calls @ Rs 45 each Buying a Rs 2,740 Reliance call at Rs 57 and buying a 2,780 Reliance call at Rs 36. The net outflow would be [(2X45)-57-36] = Rs -3. In this case, the maximum profit potential is the difference between the lower and the central position i.e. on options with Rs 2,760 and Rs 2,740 options.
The net cost of this long butterfly spread strategy is -3 Rupees. Thus the maximum potential is Rs 17 ((Rs 2,760 – Rs 2,740)-Rs 3). The maximum loss potential equals to the net premium outflow.
12. Short Butterfly spread with calls—Two long calls and two short calls
While the long butterfly helps you bet on time decay, the short butterfly spread allows you to make the most of neutral markets. This strategy involves selecting three prices of equal intervals (similar to the long butterfly spread) and buying and selling two calls for the same expiry. The only difference being that you would sell one call each below and above the central strike price and buy two calls at the center strike price.
For example, you may buy two Rs 2,760 calls @ Rs 45 each and write a call each at Rs 2,740 (@ Rs 57) and Rs 2,780 (@ Rs 36), thereby creating a net inflow of Rs 3. In this case, your maximum loss potential is Rs 20 – Rs 3 =17 (the difference between the lowest and the centre strike price adjusted for the net premium inflow). The maximum profit potential is equal to the net premium received— i.e. Rs 3.
And there you have it…
We hope these strategies help you glean more about the market, the next time you’re placing a trade. However, do remember that no strategy is good or bad by itself. The same strategy can be highly profitable under certain market conditions and incur losses in others. Thus, it is imperative to analyse market conditions without any bias and select your strike prices prudently.
That’s it for the strategies in this article, but if you’d like to know more scroll ahead as we answer some frequently asked questions on Options trading.
Frequently Asked Questions on Options Trading
How to be a "pro" options trader?
Options trading is gaining popularity in India of late, due to a variety of factors such as low initial investment requirements, sophistication of trading tools, attractive brokerage plans offered by multiple brokers, and the hype created around options trading on social media.
That said, only about 10%-12% of options traders are making profits. If you aspire to be one such trader, here are a few things to remember:
What are the most suitable options and strategies for beginners?
At the onset, options traders should be more cautious and should start with less complex strategies. Generally, the Covered options strategy, or strategies that have predictable trade-offs, are considered less risky.
Which strategies can make maximum losses?
Unless you trade prudently any strategy can result in losses. That said, some strategies have more inherent risks—writing options for instance. It is popularly said that option writers are the most successful F&O traders. Although this is true, it is equally true that naked option writing is a high-risk game.
How can I be a smart options trader with limited capital?
To be an effective options trader, you not only should care about your stop-loss discipline but also about your costs. It’s not necessary to trade every day to be a successful options trader. When it comes to trading with limited capital, you should select your strategies exceptionally carefully.
For instance, when you are betting on high volatility you have several strategy options such as long straddle, long strangle, and short butterfly spread with calls amongst others. You must carefully examine the trade-offs before selecting any of these options.
Short butterfly spreads with calls may have limited profit potential and may involve higher costs (since more call transactions are initiated) but, it’s noteworthy that the breakeven points of this strategy are realistically close as compared to those in the other two strategies.
So trading successfully with limited capital boils down to two things
Nonetheless, when it comes to profiting from any options strategy, terms like basic or advanced may become arbitrary—anything that works under the prevalent market conditions is a good options strategy.
Disclaimer:
The blog is for information purposes only and anything mentioned herein shouldn’t be construed as a fundamental reason to buy/hold/sell any stock. Furthermore, the information provided in the blog and observations made there shouldn’t be treated as the extension of recommendations made on the other properties of Ventura Securities. If you follow any research recommendations made by our fundamental or technical experts, you should also read associated risk factors and disclaimers.
We strongly suggest you consult your financial advisor before taking any decision pertaining to your finances.
We, Ventura Securities Ltd, (SEBI Registration Number INH000001634) its Analysts & Associates with regard to the blog article hereby solemnly declare & disclose that:
We do not have any financial interest of any nature in the company. We do not individually or collectively hold 1% or more of the securities of the company. We do not have any other material conflict of interest in the company. We do not act as a market maker in the securities of the company. We do not have any directorships or other material relationships with the company.
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