Introduction to Option Strategy

We have gone through how options work, the math behind options, and the Greeks involved in options trading. We shall, in this module, understand how to assimilate this information and use it to set up option trading strategies.

One reason why options are gaining importance and why retail and institutional investors are flocking toward options is the flexibility it offers.

While in a cash or futures market, a trader can execute his trading plan by either buying or selling, an options trader has close to 500 different strategies from which to capitalise on various situations.

The trader can adopt various option trading strategies if the underlying is rising, falling, or moving sideways. There are option trading strategies for a choppy market, for a market that is rapidly rising or falling, or one that is likely to rise or fall slowly. There are also option trading strategies for events like earnings day, budget days, election days, or even credit policies. A trader even has option trading strategies for occasions where nothing is expected from the market.

In short, an options trader has a wide array of instruments to choose from to benefit from any situation. The issue before a trader is now a problem of plenty.

It is not necessary that a trader needs to know all the option trading strategies to take advantage of, but the few that he knows, he should be thorough with.

Trading with a handful of strategies and knowing when to deploy which strategy is good enough.

We shall, in this module, cover a few strategies that are widely used.

However, it is important to note that knowing these option trading strategies does not guarantee 100 percent success. There is no holy grail in the market where every strategy will have a high probability of working in your favour.

Before beginning to put the Options Strategy to use, it is important to keep in mind certain salient points.

Salient points of Options Strategies

·       Option trading strategies have the potential to offer good returns. At the same time, if not handled properly, they can be the cause of ruin for a trader.

·       There is an options strategy that offers pre-defined risks and rewards.

·       The winning percentage in the option selling strategy is higher than in the option buying strategy, but the risk is higher in option selling as compared to option buying.

·       Option buying offers a theoretical unlimited reward potential with a defined risk but option selling offers a small profit potential and a theoretical unlimited risk potential.

·       Option selling can result in the trader making money even when he is wrong with respect to the direction of the move. The option buyer can end up in a loss even when the market moves in his direction, but not enough.

·       In case the underlying remains in a range, an option buyer will lose money as compared to an option seller.

·       Option strategies can be used for hedging the portfolio.

·       Option strategies can be created by using a single option or multiple options.

·       A combination of more than one option to a strategy offers many benefits. For instance, it provides margin benefit in the case of spread strategies and offers to capitalise on large movements like straddles and strangles, among many others.

If you are new to options trading, it is better to start small and use risk-defined strategies. As you gain knowledge on the subject you can explore other strategies. Gaining mastery over a handful of strategies is good enough to succeed in the market.