Options trading necessitates a deep knowledge of the stock market trend. The market can be bullish, bearish, or neutral at any given time. And for each of these conditions, there are various approaches to implement that not just increase your rewards but keep the risk factor in check. So let’s learn about the top three strategy for options trading.Â
What is the best strategy for Options Trading?
1. Long Call
It is an options strategy in which you enter the derivative contract, and the intent is to sell the underlying asset if the stock price surpasses the strike price at expiry. The earning potential here is uncapped, and your profit is multiplied based on the price movement. Here the loss is limited to the premium you pay to open the position.Â
Suppose you are bullish on the banking sector and buy a single lot of 25 shares of a Bank Nifty options contract with a long call. The strike price is Rs 8800 per share, and you paid a premium of Rs 500. The breakeven point for this trade is Rs 9,300 (strike price + premium amount). On the expiry, Bank Nifty reaches Rs 9,500. Your total profit will be Rs 5000 { ( 9,500 – 9,300) × 25}.
2. Covered Call
It is a trading strategy in which you hold a long position in a stock or other asset class and sell the call option on a contract with the same underlying asset. Covered calls are ideal when you anticipate slight fluctuations in your holdings.
Suppose you buy 1000 shares of XYZ bank at Rs 1000 each. You believe that bank share prices will not move much and that even if they do, the increase will be only Rs 100. So you sell a single call option of this share (lot size of 1000 shares) with a one-month expiry and a strike price of Rs 1050. The call option premium is Rs 30.
On expiry, the share price of XYZ bank increased to Rs 1100. So, in this case, your profit per share is Rs 1080 (strike price + premium).
To offset the risk, you are foregoing a small profit portion here. If prices fall, the premium will help to mitigate the loss.
3. Strip Strategy
This one is a neutral options strategy that lets you profit regardless of market movement. However, the premium requirement is higher because you must purchase three at-the-money (ATM) contracts, which include one ATM Call and two Puts. The underlying asset, expiry date, and strike price are all the same here.
Suppose you buy an ATM-based XYZ bank’s one ‘call’ contract with two ‘put’ options at a strike and spot price of Rs 100. The premium for the call option is Rs 6, and for the put option, it is Rs 14 (7×2). So the combined premium you pay here is Rs 20.
The price soars to Rs 140. Your net profit will be Rs 20 after deducting the premium and spot price. However, if the price falls, the premium paid will be doubled for each downtrend due to using two ATM puts. For example, say the price has dropped to Rs 60. The profit, in this case, will be Rs 60 { 2 Puts × (Rs 100 Strike Price – Rs 60 Current Price) – Rs 20 Premium Paid}.
The strip strategy has unlimited earning potential in an uptrend and limited income potential in a downtrend.
Final Words
Although various risks are associated with options trading; however, you can limit them using the proper strategy. However, not every trading approach is appropriate for every market and underlying asset. If you are a beginner, it is always best to seek the advice of an experienced F&O broker.