Stock options provide traders and investors with an easy way to control the risk-to-reward profile of a trade or investment. While some aspects of options trading can be complicated, the basics are relatively easy to understand and implement in everyday situations, since all options boil down to either buying or selling the rights to buy or sell an underlying security at specific times and prices [see ETF Call And Put Options Explained].
Options are unique in that they can be used in virtually any market condition. Bullish strategies can be employed to gain leverage, bearish strategies can be used to profit from downside, and neutral strategies can even be used to profit from a sideways market. These strategies can also be fine tuned in terms of aggressiveness by adjusting option strike prices and expiration dates.
In this section, we’ll take a look at various types of option strategies, including bullish strategies, bearish strategies, and neutral strategies [see also 101 ETF Lessons Every Financial Advisor Should Learn].
Bullish stock option strategies are used to capitalize on rising underlying stock prices, by either purchasing the right to buy or selling the right to sell. For example, a bullish investor can purchase the right to buy 100 shares of stock in a month for a couple hundred dollars instead of spending thousands on purchasing the same underlying stock, creating a levered position.
These strategies pay off when the underlying stock price moves higher, but can result in a complete loss when the underlying stock stays the same or moves lower. Often, the losses for bullish strategies are limited to the price paid for the options – known as the premium.
Some examples of bullish strategies include:
Bearish stock option strategies are used to capitalize on falling underlying stock prices, by either selling the right to buy or buying the right to sell. For example, a bearish investor can buy the right to sell stock at the current price, which would presumably be worth a lot to another investor down the road when the underlying stock price has fallen [see also 10 Questions About ETFs You've Been Too Afraid To Ask].
These strategies pay off when the underlying stock moves lower, but can result in a complete loss or worse when the underlying stock stays the same or moves higher. Sometimes, these losses can be unlimited, while the potential upside is capped at the premiums received.
Some examples of bearish strategies include:
- Long Put Options
- Naked Call Options
- Bear Put Spreads
Neutral stock option strategies are used to capitalize on sideways stock prices, by creating spreads that generate an income when an underlying stock price remains within a given range. For example, selling the right to buy and selling the right to sell will both pay off, if the stock price never reaches either point over the given time frame [see also How To Take Profits And Cut Losses When Trading ETFs].
These strategies pay off when the underlying stock remains the same, but can result in a complete loss when the underlying stock moves higher or lower. Most of the time, these losses are limited to the premiums paid to enter into the position.
Some examples of neutral strategies include:
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Disclosure: No positions at time of writing.