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With options, traders can secure the right to buy or sell a particular security or other asset later at a price that is already fixed now, regardless of the price at the time of sale. There is no obligation, however. It is therefore a conditional forward transaction.
To purchase a call or put option, the option price must be paid (premium). Traders can, however, also take the reverse position and sell call or put positions. The underlying assets can be shares, indices and ETFs, currencies, commodities, food, but also the weather.
Standardized options are traded on the Chicago Board Options Exchange or EUREX. American options can be exercised at any time, whereas European options can only be exercised at maturity. Options are used to speculate, hedge positions or realize arbitrage gains. There are four basic positions from which all options strategies can be developed.
Four basic positions from which options strategies can be developed
The four basic positions for forming an option strategy are the:
- Purchase of a call option (call long)
- Purchase of a sell position (put long)
- Sale of a call option (call short)
- Sale of a put option (Put Short)
When buying an option, the buyer pays an option premium to the seller (writer). The buyer makes a profit if the underlying price of the underlying asset has risen (call long) or fallen (put long) at the time the option is exercised. It is therefore possible to speculate on rising or falling prices.
When selling an option, the seller receives a premium and makes a profit if the price has fallen (call short) or risen (put short) in the meantime. The option is of course only exercised if a profit can be expected in each case.
The various option types or basic items can be combined with each other in any technical way. This allows you to develop a wide variety of option strategies for specific market situations.
If you already own shares, want to hedge them and expect only a moderate increase in the share price, you can use a covered call strategy to conclude a call short option (sale of a call option) on the shares and realize a profit in the amount of the option premium if the share price does not rise at all or only very moderately. If, contrary to expectations, the share price has risen too far, either delivery of the shares at the fixed price or repurchase of the call short option can be considered. Covered calls are particularly popular for generating passive income.
If, for example, one underlying asset, such as the price of a share, is expected to rise or fall sharply, i.e. regardless of which option is right, a call long can be combined with a put long option (long straddle). The buyer thus acquires a call option and a put option at the same exercise price (strike). As soon as the price change is higher or lower than the premiums paid, a profit is made.
In the expectation of strongly rising or strongly falling prices (mainly strong swings), a so-called long strangle can be formed by a call long and a put long at different exercise prices. The advantage is that the options are correspondingly cheaper than with a long straddle due to the removal of the exercise prices. The prerequisite for a profit, however, is a correspondingly higher price fluctuation in the underlying instrument.
Conversely, if the price is expected to move sideways rather than out of a certain corridor, a call short and a put short option can be purchased together at the same exercise price. If the options expire worthless, the seller earns the premiums.
If only small price fluctuations are expected, a call short and a put short position can be sold at different exercise prices as an alternative to the short strangle. The maximum profit is achieved if the price remains within the range between the strike price for the put option and the call option. However, since the buyer’s chances of winning are lower than those of the short straddle, because larger price swings must occur overall in order for the buyer to make a profit, the option premiums to be collected are also lower.
Option strategies with spreads
Spreads are formed when traders buy and sell several options of the same class but with different exercise prices or terms at the same time.
With a bull call spread, speculation is made on a moderately rising price of the underlying asset by the trader running a call long with a low strike price and simultaneously selling a call with a higher strike price. The premium from the sale of the call with a higher strike price can be used to reduce the premium for the purchase of the call long, so that a profit is still made even if the share price increases.
A similar result can be achieved with a Bull Put Spread. In which a Put long is bought when it is already out of the money and at the same time a Put short with a higher strike price is sold.
Conversely, Bear Call and Bear Put Spreads can be formed if slightly falling prices are expected.
In addition to these option strategies mentioned above, there are many other strategies for specific expectations and market constellations, some of which are considerably more complex.
As is usual with derivative financial products, considerable risks may exist. Particularly if short sales are possible, which means that the underlying assets may have to be “delivered”, but have become very expensive in the meantime, and others are not hedged. However, even short positions that are hedged with the presence of an underlying asset are subject to considerable risk of loss without hedging if prices move against expectations.
See my other posts about options:
- Bear Call Spread Options Strategy
- Bull Put Spread – Earn Money With Puts And Limit Risk
- Butterfly Spread Options Strategy
- Definition Of Option Price/Option Premium
- Earn Money With A Covered Call Options Strategy
- How to exercise Options
- How to use the Standard Deviation for Options Trading
- Iron Condor – Profit From Low Price Fluctuations
- Options Trading Tutorial for beginners
- Options vs. Futures – Two Different Types Of Futures Contracts
- Options vs. Warrants – 4 Differences
- Protective Put – Hedging Of Equity Positions
- Simple Trading Strategies for Options
- Term structure options
- What are options? – Explained Simply And Quickly
- What is a Long Call in Options Trading?
- What is a Long Put in Options Trading?
- What is a Short Call in options Trading?
- What is a Short Put in Options Trading?
- What is delta in Options Trading? – The Most Important Key Figure
- What is Historical Volatility in Options Trading?
- What is the Gamma in Options Trading?
- What is the Implied Volatility Of Options – Important Or Not?
- What is the Theta in Options Trading?
- What Is The Vega Of An Option?