Top 10 Options Investing Strategies
Neutral to Bullish Strategies
1. Long call: Simply buy a call option on a stock. This provides unlimited growth potential and limits the risk associated with the amount paid for the stock option. For example, let’s say you have $1600 and you think Google (GOOG) will increase in value: Let’s say it’s currently trading at $500 a share, but you only have enough money to buy 3 shares. Instead of buying the stock, you decide to buy call options on Google (GOOG). Let’s say you want to be conservative and only buy write-in-the-money trade options ($500 exercise). Now you just need to choose the expiration month (do you think the stock will increase in value soon or will it take a while?) Suppose you think that Google (GOOG) will increase in value within 1 month. You buy 500 September calls for $16 (you have $1000 so you can pay for 1 contract (sold in 100 plate lots). As long as Google (GOOG) trades at $516 at expiration in September, you have made a profit.
Let’s say GOOG is trading at $550 at the expiration of the call options:
If you had bought 3 shares, your profit would be ($550-500)*3 = $150.
If you bought the call options, your profit would be {(550-500)-16}*100 = $3400.
2. Put Writing (Short Put): Simply sell put options on a stock. This gives you the option premium, while your maximum risk is the option strike price minus the premium received. Your maximum risk scenario would only occur if the share price hit $0. For this strategy, an investor will typically have a neutral to bullish market forecast. Let’s say you are interested in Apple (AAPL) and you think it will increase in value or stay the same. You can sell Puts on Apple (AAPL) and receive the option premium in exchange for the risk that the stock value will decline until the expiration of the stock options you sell. Let’s say Apple (AAPL) is trading at $120. To be conservative, write put options with an at-the-money ($120) strike price for $6 each and an expiration of 1 month. Let’s say you only write 1 contract, you will receive $600. While you wait for the option to expire, you can invest that $600 somewhere else, say Google. At expiration, as long as Apple (AAPL) is trading above (120 – 6 = $114), it will have made a profit.
3. Married position: This strategy is implemented by buying the stock and purchasing a put option on the stock. This gives you protection against a price drop while you can still participate in all rises in the stock price. The risk/reward profile is very similar to the Long Call; that is why this strategy is also known as a ‘synthetic call’. Let’s go with Starbucks (SBUX). You buy 100 shares at $25 each for $2,500 and want to hedge against a drop in the Starbuck (SBUX) stock price, so you buy straight-to-the-money put options because you’re being very conservative. Let’s say you only want to protect your stock from falling for 1 month. You buy put options with a strike price of $25 1 month to expiration for, say, $1. Now the most money you can lose during the month is the $1 you paid for the put, while you can still participate in any profit, as long as Starbucks (SBUX) trades above $26 at expiration, you will have made a profit.
Neutral to Bearish Strategies
4. Long position: Simply buy put options on a stock. This strategy is implemented when an investor has a bearish forecast for a stock. Let’s say you think the price of Google (GOOG) will decrease over the next month. Instead of shorting Google (GOOG), you decide to buy put options on Google (GOOG) because you don’t want to risk as much money. Let’s say Google (GOOG) is trading at $500. If you were to sell stocks short, you need to be able to hedge your position. Let’s say you have $1500, you could cover the reduction of 3 shares. If you buy puts and are conservative, you could sell $500 at-the-money puts for a month for, say, $15. You could afford 1 contract (100 shares). If you had shorted the stock, you would profit as long as the stock declines in value, but you have unlimited upside risk. With Google Put Options (GOOG), your risk is limited to your initial investment, while your rewards can be substantial.
Let’s say Google (GOOG) in a month is now trading at $450:
If you shorted the stock, your profit would be ($500 – $450) * 3 = $150
If you bought the put options, your profit would be ($500 + $15 – $450) * 100 = $6500
5. Call writing: Simply write (sell) call options on a stock. This gives you the premium option while your maximum risk is infinite (stocks can potentially go up to infinity ha). For this strategy, an investor will typically have a neutral to bearish market forecast. Let’s say you’re interested in Apple (AAPL) and you think its value will depreciate over the next month or stay the same. You can sell call options on Apple (AAPL) and receive the option premium in exchange for the risk that the stock will increase in value during the month. Let’s say Apple (AAPL) is trading at $120 and you are going to be conservative and write put options with a strike price at the money ($120). Receive $5 bonus. As long as the price of Apple (AAPL) is less than (120 + 5 = $125) at expiration, you have made a profit.
6. Protected Short Sale: This strategy is implemented by shorting the stock and purchasing a call option on the stock. This gives you protection against a rise in the stock price while you can still participate in the fall in the stock price. The risk/reward profile is very similar to the Long Put; that is why it is also known as a ‘synthetic put’. Let’s go with Starbucks (SBUX) again. You can short 100 shares at $25 each for $2,500 and want to hedge against a rise in stock price, so you buy calls on Starbucks (SBUX) directly because you’re conservative. Let’s say you only want to protect your stock from falling for 1 month. You buy calls at Starbucks (SBUX) with a strike of $25 and 1 month to expiration for $1. Now, the most you can lose during the month is the $1 you paid for the sale while you can still participate in any decline in the stock price. As long as Starbucks (SBUX) is trading for less than $24 at expiration, you will have made a profit.
Neutral Option Strategies:
7. Short Straddle: This strategy is implemented by simultaneously writing a put option and a call option on the same share with the same exercise price and the same expiration date. This way, as long as the stock price remains somewhat stable, you will make a profit. For example, let’s say Google (GOOG) is trading at $500 and you think it will stay near that price for the next month: sell Google (GOOG) $500 Call for $16 and sell Google (GOOG) $500 Put for $15, both with maturities around of 1 month As long as the Google (GOOG) price at expiration in one month trades above ($500 – (15 + 16) = $469) and below ($500 + (15 + 16) = $531), there will be made a profit.
8. Short Combination (Short Choke): This strategy is similar to the Short Straddle in that you write a call option and a put option; however, the difference is that with a short combination different strike prices are used. This way, you can increase your profit window of opportunity in case there is a price movement. For example, let’s say Apple (AAPL) is trading at $120/share and you think the price will be somewhat flat over the next month, but there are a few more causes than Short Straddle Investor: Sell Apple (AAPL) $130 Calls for $2 and sell Apple 110 (AAPL) Puts for $3; both with one month expiration. As long as Apple shares remain above (110 – 3 – 2 = $105) and below (130 + 3 + 2 = $135), you have made a profit. This way, you will receive a smaller option premium, but you are more likely to make a profit.
9. Straddle Length: This strategy is the opposite of the Short Straddle; An investor will simultaneously buy a call option and a put option on the same stock with the same strike price and expiration date. Investors use this strategy when they believe there will be a great price on a stock, but are unsure in which direction the stock will move. This strategy can work well when a major early stock decision is about to be made: buyback program, lawyer pool, new technology, earnings reports, presidential election. For example, let’s say the United States presidential election is coming up next month and you want to find a way to make a profit. Some stocks will move based on which candidate wins and you decide to focus on Starbucks (SBUX). Let’s say one candidate wants to increase taxes on milk and the other wants to decrease them. You know this will affect the bottom line for Starbucks (SBUX), so you decide to implement a long straddle because you’re not sure which candidate will win. You buy calls and puts with the same strike price at Starbucks (SBUX) and the same expiration month. When the decision is announced, the stock will most likely move sharply in one direction. As long as the stock moves in one direction more than the amount you paid in option premium, you will make a profit.
10. Time spreads (calendar spreads): This strategy is implemented by buying and writing an equal number of put or call options on the same shares with different expiration dates but with the same exercise prices. Normally, time spreads have a neutral basis, but they can also be designed for a bullish or bearish basis. For example, sell $500 Calls on Google (GOOG) with 1 month expiration and buy $500 Calls on Google (GOOG) with 6 month expiration. You can make a profit if calls with a shorter expiration time lose value faster than calls with a longer expiration time. This tends to work as the time value component of an option security generally erodes faster the shorter the time to expiration. However, you should consider other aspects of option pricing, such as volatility.
