Posts Tagged ‘options trading’
Options Trading Strategies
May 8th, 2011
Stock and Bond trading strategies run the gamut from the simple ‘buy and hold forever’ to the most advanced use of technical analysis. Options trading has a similar spectrum.Options are a contract conferring the right to buy (a call option) or sell (a put option) some underlying instrument, such as a stock or bond, at a predetermined price (the strike price) on or before a preset date (the expiration date).So-called ‘American’ options can be exercised anytime before expiration, ‘European’ options are exercised on the expiration date. Though the history of the terms may lie in geography, the association has been lost over time. American-style options are written for stocks and bonds. The European are often written on indexes.Here are some strategies for options trading.
1 – Buying Options
When buying a call option or put option, you are only required to pay one commission when you enter the position, and if you exit that position, there is only commission charge, which nets out to two total commissions.If you are absolutely wrong about the direction of the underlying security, you may never have to close out the position, because it will be worthless before you can take any kind of constructive action.
2 Writing Naked Options
Along with buying options, writing naked options create the smallest commission costs.When you are writing naked options, in many cases, especially if they are way out of the money, you may not have to close out the position at all. The option simply expires, and when it does, there are no commissions involved in the closing of the transaction.With writing out-of-the-money options, the chance that you will have to close out that option position may occur only 20% to
30% of the time. The other 70% of the time, the options that you write will expire with no exit commission costs.
3 – Out-of-the-Money Spreads
The next most attractive strategy from a commission standpoint is the out-of-the-money spread.For example, far-out-of-the-money index credit spreads will expire 80% to 90% of the time. Therefore, there will usually be only two commissions incurred to enter, but none to exit the position.
4 – Naked Strangles
The next cheapest strategy with regard to commission costs per dollar invested is writing a naked strangle (a strangle consists of a call and put with different strike prices, but with the same maturity and underlying asset), where both the naked call and the naked put are out of the money.
5 – Covered Options Writing
The final ranking strategy is a conservative one — covered options writing.This strategy will normally generate small commission costs if you hang onto your pivotal common stocks, and are not active in buying and selling common stocks to use as the merchandise in your covered option writing program.By avoiding excessive trading of both options and common stock when writing covered options, you will greatly reduce the commission costs per dollar invested.
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