The best options trading strategies are used primarily for speculative and hedging purposes. A virtually unlimited number of strategies can be created by incorporating various option positions resulting in a strategy designed to accomplish a specific goal. The goal may be to protect currently held assets or to speculate on the anticipated price movement of an underlying financial instrument. The investor can select from the most commonly used strategies or create a custom strategy. The best trading strategy is the one that will accomplish the financial goal of the investor.
Hedging can be a form of insurance on an asset or portfolio. The investor who owns shares of a company may want to protect the investment against an adverse price change. Buying a put is a strategy that offers the trader the right to sell the stock at a specified strike price on or before the expiration date of the option contract. The strike price is the exercise price of the contract and is selected by the trader. Index options cover a broad range of stocks and can be used to hedge a portfolio of stocks. The investor owning shares in energy related stocks may want to protect the investment by purchasing a put on an energy index. If the value of the portfolio declines, the value of the put option will typically increase, creating a hedge.
The investor anticipating an increase in the value of a stock can buy a call option to capitalize on the move. A long call offers the investor the right to buy an asset at the strike price on or before expiration of the option contract. A call will typically increase in value as the underlying stock increases in value. Buying a call is much less expensive than buying the stock, and the risk is limited to the premium paid for the call. Speculating on a decline in the value of an asset can be accomplished by buying a put option. Once again, the risk is limited to the premium paid and the trade is far less expensive than short selling the stock. The investor expecting a general market movement can speculate using index options.
Complex option strategies are used for a variety of trading opportunities. Options can be bought and sold with different strike prices and expiration dates, creating limited risk strategies. These methods enable the investor to capitalize on market conditions that could not be traded using simple long and short stock positions.
Some option strategies are used to trade specific market conditions such as a trending, choppy or consolidating market. Trading a volatile or erratic market is typically accomplished using complex option strategies. Market-neutral positions can be established that lower the exposure to unexpected volatility. Option trading strategies are available for nearly every type of market condition.
Dana DeCecco has been writing for Lakeside Venture Capital for three years and has has maintained financial websites since 1998. Holding a Series 3 license, DeCecco is a former commodity trading adviser with an extensive knowledge of trading financial markets. He studied business at Penn State University.