An option s value is based upon another derivative, such as a stock or a bond. Options that are based upon stock are called stock options. Investors may purchase a stock option for a specified price over a given time period.
In a previous article entitled, Options Trading, several options trading strategies were mentioned, but not discussed. This article will explain the various strategies in detail and define concepts.
Options premiums are defined by their expiration date, market price, interest rate, volatility of a supporting security, and dividend rates. Options premiums are further defined by time value and intrinsic value.
The difference between the stock price and strike price is called the intrinsic value. The option is determined to have zero intrinsic value if it is below market value. Therefore, intrinsic value describes an option that is in-the-money.
An options time value describes the time remaining before the option reaches its expiration. After the expiration date, an option holds no value. The difference between the supporting security and the strike price is often referred to as the moneyness of an option. At-the-money, in-the-money, and out-of-the-money are terms used to describe the difference between the supporting security and the strike price. The fluctuation of the options price is called volatility.
LEAPS is an acronym for Long-Term Equity Anticipation Securities. Investors who desire a long term investment should consider the LEAPS strategy. Most investors who utilize the LEAPS strategy intend to invest for a length of two years or more.
Bullish Trading Strategies
When the prices of the underlying securities are rising and the market is deemed strong, the market is said to be a bull market. Investors employ bull trading strategies in a bull market. With this strategy, each investor must predict how high the stock option price will rise and how long the rally will last. This will help the investor determine when to enter and exit the market.
Bull Call and Bull Put Strategies
Investors who utilize this strategy will profit from small incremental changes in the underlying security.
Out-of-the-money Covered Call
Conservative investors may utilize the covered call approach. Covered calls are designed to protect investors from a decline in an underlying stock. If the investor owns shares of a supporting stock, he or she may purchase more shares of the same stock to protect the purchase or earn more dividends. When both the supporting stock and the options are purchased simultaneously, it is called a buy-write. If the stock is previously owned and then the option is purchased, it is called an overwrite.
Investors often employ the overwriting strategy when they assume the value of the option is skewed or incorrect. Options writers will sell call or put options hoping that no one will exercise the option. Buyers will hold the options until they expire. The options writer will collect the premium on the option.
Bearish Trading Strategies
When the underlying security is expected to decline in price, investors employ a bearish trading strategy. Investors must predict the lowest point the underlying security will reach and the time frame in which this particular decline will occur.
Bear Call Spread
Bear call spreads are in-the-money transactions. This strategy involves selling call options at a lower strike price than the security was purchased.
Bear Put Spread
Investors, who purchase options when the option is in-the-money and sell when the option is out-of-the-money, profit from the difference in price.
Neutral trading strategies will be discussed in a later article. Neutral trading strategies are employed when investors are unable to predict the movement in the market. Some of the neutral trading strategies are listed below:
- Risk Reversal
- Time Spread
Stock analysis software is available to assist with each of these strategies listed above. Most of the stock analysis software supports options trading. Investors seeking tools that will assist with identifying these strategies should consider those listed on Top Ten Reviews. Xtend by Options Xpress and others mentioned on the Top Ten Reviews site will help investors identify the best time to utilize each of the strategies listed above.