Option Trading Strategies

Module 3: Basic Strategies
Lesson 1: Option Trading Strategies

Puts and Calls form the basic building blocks of all option trading strategies.

Every trade is built using only Call options, only Put options, or a combination of the two.

If you are excited or overwhelmed by the number of stock trading strategies available to learn, then you'll feel the same way about options trading.

There are a larger number of option trading strategies available to the options trader.

I'm not a fan of information overload so I'll only share a few of the basics with you.

One of the great benefits of stock options is their versatility. You can tailor a particular trading strategy to be conservative, aggressive, or somewhere in between.

Here are just a few of the benefits of using stock options in your overall investment plan:

• You can benefit from a rise or fall in stock price without actually owning the stock.
• You can position yourself for a big move in the stock price even if you don't know which way prices will go.
• You can earn extra income off of your current stock holdings.
• You can buy stocks at a lower price then what they're trading at.
• You can protect yourself from losing money if your stock declines in price.

Before we proceed into the option trading strategies I want to introduce you to a few new concepts. You'll also be introduced to new options trading terminology (trading "lingo").

New Concepts

A stock option is a contract and the contract has two parties involved, a buyer and a seller. Both Puts and Calls must have a buyer and a seller.

Buy to Open and Sell to Close
Not in all cases, but for most, a buyer will pay for a contract that they think will increase in value. When you open a new position buy buying an option this is what they consider "buy to open". You're buying an option to open a new position.

They will either exercise the contract or sell it to someone else for a profit. When you sell it to someone else for a profit this is what they consider "sell to close". You're selling your option to close out your position.

**Buy to open and sell to close go together**

Sell to Open and Buy to Close
Sellers of stock options are in it to make money off the premium they receive when they sell the option. The seller receives money from the buyer, and they think the contract will go down in value and eventually expire worthless. This is how sellers make money; they get to keep the premium they collected.

When you open a new position by selling an option this is what they consider "sell to open". You're opening a new position by selling an option to someone else.

If things don't go as planned and you need to close out this type of position then you must buy back your option. You must buy to close. You're buying back your option to close out the position.

**Sell to open and Buy to close go together**

Rights Vs. Obligations
If you buy or own (buy to open) a stock option contract it gives you the right, but not the obligation, to buy or sell shares of a stock at a set price on or before a give date. So the person who buys an option has "rights".

Option BUYERS have right RIGHTS
Option SELLERS have OBLIGATIONS

The person who sold you that option (sell to open) is obligated to fulfill the terms of the stock option contract. So in the case of a Call option, they are obligated to let you buy the stock at the set strike price.

In the case of a Put option they are obligated to sell the stock to you at the set strike price.

Option Trading Strategies
(Going Long vs. Short)

• Buyers are considered to be long the position.
• Sellers are considered to be short the position. Another term they use for seller is writer.

I'm a simple guy I prefer to just say buy and sell, however using long and short is more common in the financial community. I don't know why people make things so complicated.

**Side Thought** I spoke with a very wealthy individual a few years back and he told me his conspiracy theory was that he felt the financial industry complicates things to keep the average individual in the dark. If the average individual feels they don't understand something they are most likely willing to go to an "expert" to have them manage their money.

I digress, back to the lesson...

I will use the terms (long, short, etc.) sparingly from this point on to help you become familiar with them. The table below shows all the terms and their equivalents:

Basic Option Trading Strategies

Find the strategy that you like best and stick with it. At least until you make large sums of money.

This lesson just goes over the basics. I've made most of my money just sticking with the basics. I trade a few advanced option trading strategies here and there, but the basics are my bread and butter.

There are four basic option positions: long Call options (buying Call options), short Call options (selling Call options), long Put options (buying Put options), and short Put options (selling Put options).

Option Trading Strategies to
Protect Profits

• A Married Put Position (AKA Long a Put option and a Stock)
• Buying a Protective Put (AKA Long a Put option)

Option Trading Strategies for
Down Trending Stocks

• Buying Put options (AKA Long Put options)

**Tip** If you get confused by the term or forget, just remember that a bear usually stands up on its hind legs and swipes "down" with its front claws. Hence, bear markets are when stocks go down in price.

Option Trading Strategies for
Stocks that are Rising

• Buying Call options (AKA Long Call options)

Option Trading Strategies for
Stocks That Aren't Moving

• Covered Call Options

You can proceed to Module 4 (Stock Charts) whenever you feel you are ready.

Return to the top of page "Option Trading Strategies"

Return to options trading "Home Page"