Basics Of Options Trading Explained

Basic options trading strategies

Basic options trading strategies

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The bull call spread was executed when we thought the stock would be increasing, but what if we analyse and find the stock price would decrease. In that case, we use the bear put spread.

Let&rsquo s assume that we are looking at the different strike prices of the same stock with the same expiry date.

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In summary, you can take either a bullish or bearish position on an underlying instrument—a stock, an exchange-traded fund (ETF) or an index—using either calls or puts. What you use simply depends upon whether you buy or sell them first.

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Why use it: If you’re not concerned about losing the entire premium, a long call is a way to wager on a stock rising and to earn much more profit than if you owned the stock directly. It can also be a way to limit the risk of owning the stock directly. For example, some traders might use a long call rather than owning a comparable number of shares of stock because it gives them upside while limiting their downside to just the call 8767 s cost — versus the much higher expense of owning the stock — if they worry a stock might fall in the interim.

There are two basic ways of trading options: buying (long) and selling (short). When our trade is profitable, the option is in-the-money (ITM) when our trade makes a loss, the option is out-of-the-money (OTM). If we break even, our trade would be at-the-money (ATM).

Example: XYZ stock trades at $55 per share, and a put at a $55 strike can be sold for $5 with an expiration in six months. In total, the put is sold for $555: the $5 premium x 655 shares. The payoff profile of one short put is exactly the opposite of the long put.

The bear put spread strategy is another form of vertical spread like the bull call spread. In this strategy, the investor will simultaneously purchase put options at a specific strike price and sell the same number of puts at a lower strike price. Both options would be for the same underlying asset and have the same expiration date. This method is used when the trader is bearish and expects the underlying asset 8767 s price to decline. It offers both limited gains and limited losses.

The upside of a strangle strategy is that there is less risk of loss, since the premiums are less expensive due to how the options are out of the money - meaning they&apos re cheaper to buy. xA5

We use option trading examples and visual illustrations of practical options strategies, to help you better understand options trading and how to trade them correctly.

As with any options strategy, before you decide to enter a long put trade, be sure to find the maximum gain, maximum loss and breakeven points. The formula for these calculations on a long put trade is as follows:

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