As seen on:
ntv-logo sky-logo comedy-central-logo

Option Trading Strategies

Using options in your trading/investing is basically adding an additional dimension to your risk trading. Being long or short is a two dimensional game, while using option gives it a third dimension. Professional volatility trading is an area best suited for hedge funds and prop desks as it requires sophisticated systems/risk management tools and is capital intensive, but there are various strategies involving the use of options to enhance portfolio payoffs even for the less sophisticated user.

Options spreads where you own the underlying is a way to enhance portfolio value by using options. Below are a few strategies worth looking at:

Covered call

The covered call is created by selling a call against a long underlying position. The purpose is to enhance portfolio performance by cutting profit opportunities to the upside as you receive premium for the sold call. You need to be prepared to sell the underlying should the stock close above the strike price you decide to sell. Preferably this strategy is done when volatility is high as the premium you receive will be bigger.

The covered call strategy is best suited for the investor who believes in a relatively boring or slightly falling market.

Covered Strangle

Covered strangle is created by selling a call and a put against a long underlying. The strategy enhances portfolio performance if the stock stays between the strikes. The trader needs to be prepared to sell the underlying if exercised on upside and must be prepared to buy more underlying if exercised on downside. Since the trader sells premium the strategy is best done if volatility levels are high!

Top 3 Stock Broker Comparison

1
of 10 Stock Broker eToro
National fees £0.00
Custody fee £0.00
Intl. fees £0.00
Dep. Protection £50.000
Go to Broker
Risk warning: Capital can be lost. Terms and conditions apply.
2
of 10 Stock Broker Interactive Investor
National fees £7.99
Custody fee £9.99 monthly
Intl. fees £7.99
Dep. Protection 50.000 GBP
Go to Broker
Risk warning: Capital can be lost. Terms and conditions apply.
3
of 10 Stock Broker IG Stock
National fees £ 8,00
Custody fee £ 8,00
Intl. fees 10 EUR
Dep. Protection £50000
Go to Broker

74% of retail investor accounts lose money when trading spread bets and CFDs with this provider. You should consider whether you understand how spread bets and CFDs work, and whether you can afford to take the high risk of losing your money. Professional clients can lose more than they deposit. All trading involves risk.

Fairly boring market with falling volatility is best suited for the covered strangle strategy.

Covered Ratio Spread

The covered ratio spread is established by buying a call on one strike and selling the double amount of call options on a higher strike. You also need to be long/buy the underlying.

The covered ratio spread benefits if the underlying stays in a specific price interval at expiry.

There are many options strategies to use in order to enhance portfolio performance. Investors are many times not viewing their portfolio in a dynamic way and focus on being either long or short.

Most investors have views of a stock reaching a specific level, but they fail to use options in order to dynamically adjust their risk according to their views.

What do you do if you want to take profit but stay long? You can sell your stock, and use a small portion of the profit to buy calls. Should the stock go down you will only lose the premium you paid for the calls. Should the stock continue higher the long calls position will start to produce leverage and the investor will once again be long the underlying.

Another example of staying long but using options is; assume the investor is long 2000 shares and the stock reaches the price target (the investor doesn’t want to sell all stocks here). The trader can sell 1000 shares, buy 10 upside calls and sell (short) 10 downside puts. The buying of the call is financed by selling of the put (depending on preference you will need to choose the strikes yourself).

If the stock goes lower you will get to buy the 1000 shares you sold at the strike price of the put you sold short. You will in this case get to buy the stock lower than where you sold it. Note, you will lose the call premium as the stock goes lower, but you are still much better of than having not done anything.

If the stock goes higher you will become long again as the call leverage will start kicking in. Note the call premium paid will be financed by the selling of the put. The above simple example is a much more dynamic way of thinking about your portfolio than simply just holding your stocks and not adjusting the risk in accordance to your views.

There are various options strategies that don’t involve being long the underlying. Below are a few examples.

What is forex and how can you trade it?

What is forex and how can you trade it?

Forex

What is forex trading? Forex trading’s simplest definition is the act of speculating on how currency pairs react to the market with the aim of making money out of said speculation. It involves bu [...]

Let’s Learn About Forex and Forex Trading

Let’s Learn About Forex and Forex Trading

Forex

In this article we will learn about Forex markets. Forex, is an abbreviation for the foreign exchange markets and is also known as FX, or the currency markets. We will look at what

Forex is, [...]

Bull Spread

The bull spread is constructed by buying one call option and selling a higher strike option of the same type. It always has limited risk and usually the premium paid for the spread is the cost for the strategy. The profit is limited to a maximum profit = strike difference – premium paid.

The bull spread benefits from a rising market.

Pay off with a bull spread.

The inverse to the bull spread above is the bear spread. It has similar characteristics but with the preference of a view of a falling market.

Pay off with a bear spread.

Ratio spread

Ratio spreads involve buying the option of one strike and selling twice or more options of another strike. The strategy can be conducted in calls or puts and can be constructed for a view of the market moving up or down. Note that the risk is unlimited as you will end up net short options.

Below is an example of a ratio spread.

  • Buy 90-call @ 4 and sell the twice the amount of the 95-call @ 2. Premium paid is 0!
  • Max pay off is 5
  • Note the unlimited risk on the upside

Source: Orc software

1
of 28 Forex Broker HYCM
Currency pairs 69 Currencies
Max. Lever 1:500
Trading size Micro-Lot
Minimum deposit $ 100
Go to Broker
Risk warning: Capital can be lost. Terms and conditions apply.
2
of 28 Forex Broker ETFinance
Currency pairs Currencies
Max. Lever 1:30
Trading size Micro-Lot
Minimum deposit £ 250
Go to Broker
Risk warning: Capital can be lost. Terms and conditions apply.
3
of 28 Forex Broker FXTM
Currency pairs 51 Currencies
Max. Lever 1:30
Trading size Micro-Lot
Minimum deposit £ 10
Go to Broker
Risk warning: Capital can be lost. Terms and conditions apply.
4
of 28 Forex Broker ITRADER.com
Currency pairs 50 Currencies
Max. Lever 1:30
Trading size Micro-Lot
Minimum deposit £ 250
Go to Broker
Risk warning: Capital can be lost. Terms and conditions apply.
5
of 28 Forex Broker GMO Trading
Currency pairs 60 Currencies
Max. Lever 1:30
Trading size Micro-Lot
Minimum deposit $ 250
Go to Broker
Risk warning: Capital can be lost. Terms and conditions apply.
1
of 6 ETF Broker IG
ETFs w/ discount 1200
Custody fee 0 GBP
Min. deposit £ 0
Trading from 5 GBP
Go to Broker

74% of retail investor accounts lose money when trading spread bets and CFDs with this provider. You should consider whether you understand how spread bets and CFDs work, and whether you can afford to take the high risk of losing your money. Professional clients can lose more than they deposit. All trading involves risk.

2
of 6 ETF Broker Fidelity
ETFs w/ discount 93
Custody fee 0 GBP
Min. deposit £ 2.500
Trading from 25 GBP
Go to Broker
Risk warning: Capital can be lost. Terms and conditions apply.
3
of 6 ETF Broker AJ Bell Youinvest
ETFs w/ discount 0
Custody fee 0 GBP
Min. deposit £ 0.00
Trading from 1,50 GBP
Go to IG
Risk warning: Capital can be lost. Terms and conditions apply.
4
of 6 ETF Broker Bestinvest
ETFs w/ discount 216
Custody fee 0.4% annually
Min. deposit £ 500
Trading from 0 GBP
Go to IG
Risk warning: Capital can be lost. Terms and conditions apply.
5
of 6 ETF Broker DEGIRO
ETFs w/ discount 740
Custody fee 0 GBP
Min. deposit £ 0
Trading from 1,75 GBP + 0,004%
Go to Broker
Risk warning: Capital can be lost. Terms and conditions apply.
1
of 10 Stock Broker eToro
National fees £0.00
Custody fee £0.00
Intl. fees £0.00
Dep. Protection £50.000
Go to eToro
Risk warning: Capital can be lost. Terms and conditions apply.
2
of 10 Stock Broker Interactive Investor
National fees £7.99
Custody fee £9.99 monthly
Intl. fees £7.99
Dep. Protection 50.000 GBP
Go to Broker
Risk warning: Capital can be lost. Terms and conditions apply.
3
of 10 Stock Broker IG Stock
National fees £ 8,00
Custody fee £ 8,00
Intl. fees 10 EUR
Dep. Protection £50000
Go to Broker

74% of retail investor accounts lose money when trading spread bets and CFDs with this provider. You should consider whether you understand how spread bets and CFDs work, and whether you can afford to take the high risk of losing your money. Professional clients can lose more than they deposit. All trading involves risk.

4
of 10 Stock Broker Calamatta Cuschieri
National fees £ 7.50
Custody fee £ 0.00
Intl. fees £ 7.50
Dep. Protection 100.000€
Go to Broker
Risk warning: Capital can be lost. Terms and conditions apply.
5
of 10 Stock Broker Hargreaves Lansdown
National fees 11,95 £
Custody fee 0,00 £
Intl. fees 11,95 £
Dep. Protection 50.000 £
Go to Broker
Risk warning: Capital can be lost. Terms and conditions apply.
1
of 28 CFD Broker HYCM
FTSE spread 20 Points
Dep. Protection £ 50.000
Max. Lever 1:500
Min. deposit $ 100
Go to Broker
Risk warning: Capital can be lost. Terms and conditions apply.
2
of 28 CFD Broker ETFinance
FTSE spread 1 Point
Dep. Protection € 20.000
Max. Lever 1:30
Min. deposit $/€/£ 0
Go to Broker
Risk warning: Capital can be lost. Terms and conditions apply.
3
of 28 CFD Broker FXTM
FTSE spread 1.0 Point
Dep. Protection € 20.000
Max. Lever 1:30
Min. deposit £ 10
Go to Broker
Risk warning: Capital can be lost. Terms and conditions apply.
4
of 28 CFD Broker ITRADER
FTSE spread 1 Point
Dep. Protection € 20.000
Max. Lever 1:30
Min. deposit £ 250
Go to Broker
Risk warning: Capital can be lost. Terms and conditions apply.
5
of 28 CFD Broker GMO Trading
FTSE spread 1 Point
Dep. Protection € 20.000
Max. Lever 1:30
Min. deposit $ 100
Go to Broker
Risk warning: Capital can be lost. Terms and conditions apply.
1
of 17 Crypto Broker eToro
Crypto currencies 10
Max. Lever 1:2
Min. deposit $ 200
BTC spread 1,50%
Go to eToro
Risk warning: Capital can be lost. Terms and conditions apply.
2
of 17 Crypto Broker ETFinance
Crypto currencies 5
Max. Lever 1:2
Min. deposit £ 250
BTC spread 1%
Go to Broker
Risk warning: Capital can be lost. Terms and conditions apply.
3
of 17 Crypto Broker IQ Option
Crypto currencies 15
Max. Lever 1:2
Min. deposit $ 10
BTC spread 6 percent
Go to Broker
Risk warning: Capital can be lost. Terms and conditions apply.
4
of 17 Crypto Broker ITRADER
Crypto currencies 33
Max. Lever 1:2
Min. deposit £ 250
BTC spread Floating
Go to Broker
Risk warning: Capital can be lost. Terms and conditions apply.
5
of 17 Crypto Broker GMO Trading
Crypto currencies 33
Max. Lever 1:2
Min. deposit $ 100
BTC spread varied
Go to Broker
Risk warning: Capital can be lost. Terms and conditions apply.
1
of 7 Social Trading Broker eToro
Underlying assets 866
Dep. Protection 50.000
Min. deposit £ 200
Max. Lever 1:30
Go to Broker
Risk warning: Capital can be lost. Terms and conditions apply.
2
of 7 Social Trading Broker ZuluTrade
Underlying assets 200
Dep. Protection
Min. deposit £ 0
Max. Lever 1:30
Go to Broker
Risk warning: Capital can be lost. Terms and conditions apply.
3
of 7 Social Trading Broker Ayondo
Underlying assets 90
Dep. Protection 1000000
Min. deposit £ 2000
Max. Lever 1:30
Go to Broker
Risk warning: Capital can be lost. Terms and conditions apply.
4
of 7 Social Trading Broker Tradeo
Underlying assets 122
Dep. Protection 20000
Min. deposit £ 250
Max. Lever 1:30
Go to Broker
Risk warning: Capital can be lost. Terms and conditions apply.
5
of 7 Social Trading Broker FXTM
Underlying assets 247
Dep. Protection 20000
Min. deposit £ 10
Max. Lever 1:30
Go to Broker
Risk warning: Capital can be lost. Terms and conditions apply.
1
of 9 Spread Betting Broker City Index
FTSE spread 1 Point
Dep. Protection 50000
Max. Lever 1:20
Min. deposit £ 100
Go to Broker
Risk warning: Capital can be lost. Terms and conditions apply.
2
of 9 Spread Betting Broker FX Pro
FTSE spread 1.5 Points
Dep. Protection 50000
Max. Lever 1:30
Min. deposit £ 100
Go to Broker
Risk warning: Capital can be lost. Terms and conditions apply.
3
of 9 Spread Betting Broker IG
FTSE spread 1 Point
Dep. Protection 50000
Max. Lever 1:30
Min. deposit £ 0
Go to Broker

74% of retail investor accounts lose money when trading spread bets and CFDs with this provider. You should consider whether you understand how spread bets and CFDs work, and whether you can afford to take the high risk of losing your money. Professional clients can lose more than they deposit. All trading involves risk.

4
of 9 Spread Betting Broker Core Spreads
FTSE spread 0.8 Points
Dep. Protection 50000
Max. Lever 1:30
Min. deposit £ 10
Go to IG
Risk warning: Capital can be lost. Terms and conditions apply.
5
of 9 Spread Betting Broker OANDA
FTSE spread 1 Point
Dep. Protection 50000
Max. Lever 1:30
Min. deposit £ 0
Go to broker
Risk warning: Capital can be lost. Terms and conditions apply.

The above strategy as an image with payoffs and risks involved.

In a back spread the trader sells one option and buys two options (of the same type) on another strike. It can be done using calls or puts and can be constructed for up/downside preference. It is a relatively cheap way to get exposure for big market moves.