What is an Options Strategy?

Options trading strategy might be a new word for the novice in the stock market, so how about clarifying the definition of options strategy? The options strategy is a derivative instrument with maximum profit. The options strategy is a simultaneous buy or sell of stock in one or many other ways. It is also called trading strategies.

Options strategy has two main actions : Call and Put option.

Call options allow traders to buy any particular stock at a strike price for upside trading. Put options used to buy for downside trading.

A call allows buyers to trade on the upside movement, whereas the put option allows buyers to trade on the downside movement.

Amid the calls and puts of the stock, traders earn a maximum profit according to the market fluctuation. It helps them to eliminate the risk factor of the stock. The benefit is that even if you cannot gain, the loss will be only a premium amount.

In this blog, we will learn about the top 5 options strategies for investors and traders.

5 Best Options Strategy of the Indian Stock Market:

1)  Bull Call Spread

A bull call spread strategy or a bullish strategy is used when one thinks the market will go to an upside movement in the near time but will not extend to the resistance level.

The bull call spread strategy is favourable only when investors think the market will be bullish. It is also termed a debit call spread.

This strategy consists of two call options: lower strike price and upper strike price. The gain and loss in the bull call spread strategy are limited due to the upper and lower strike prices. Investors buy call options with a lower strike price and sell at a higher strike price and expiration date should be the same.

When the price exceeds the higher strike price at the expiration, traders earn a maximum profit. Once the range is decided, if the stock price falls compared to the lower strike prices, it will be considered a top loss. And if the stock price rises compared to the higher strike price it will be a top profit.

It has another concept of bear call spread consisting of one short call with lower strike rate and one long call with higher strike rate.

Merits and Demerits of Bull Call Spread

MERITS	DEMERITS
1) Investors can decide the maximum loss and maximum profit.	In buy call spread profit will be limited.
2)   A bull call spread buying is cheaper than individual share purchasing.	The trader forfeits any gains in the stock price above the strike of the sold call options.

2) Bull Put Spread

Bull put spread is an options strategy used by traders or investors for buying underlying assets when they expect a moderate bull in the stock.

This strategy is for option sellers who do not want to take more risk and take a predicted profit. Any sudden movement in the strike price will fluctuate their profit or eventually hit their stop loss. So, to protect his fund, one should use this strategy.

The investor enacts the bull put spread by buying the investment with a lower strike price and selling within the same day with a higher strike price. In other words, the traders invest in put options when in bearish stock.

The bull put spread consists of two options: 

1) They will buy a bearish stock and pay a premium, and 

2) They will sell another stock and receive a premium for that sale. The expiration date of both must be the same.

Another concept of put spread is bear put spread, consisting of one long put with higher strike rate and one short put with lower strike rate. It has the same buying and selling in the future with the same expiration date. 

Merits and Demerits of bull put spread:

MERITS	DEMERITS
1) Those who are bullish in underlying assets can use this strategy.	There is a high risk of loss in this strategy.
2)   It is realized when the price of stocks is above the higher strike price.	Investors will lose if the stock price is below the upper strike price.

3)  Call Ratio Back Spread

The call ratio back spread strategy is used for purchasing more stocks or bulk lots of stock and then selling it in a small amount.

The investors buy higher call options at a higher strike price and sell them at a different price in the ratio of 1:2, 1:3 or 2:3.

They will sell at a different price but with the same expiration date. This will help them to earn a massive profit. Bullish traders use this strategy to maximize profit and limit the chances of loss.

Traders use call ratio backspread to improve the movement of trade and increase profitability. They use variations depending on the market situation, and the most used variation is 2:1 (Buy 02 Calls at a higher strike rate and sell 01 calls at a lower strike rate).

Just like call ratio back spread, another trading strategy is covered calls, is a strategy in which calls are purchased or owned and are sold on share-for-share basis.

Merits and Demerits of Call Ratio Backspread:

MERITS	DEMERITS
1) It will result in a profit if there is a rapid change in price due to implied volatility	It will result in loss if there is no  change in price contrast from other strategies.
2)   Call ratio back spread provides a ratio to trading long and short.	To use the call ratio back spread strategy investor requires experience and expertise.

4) Long and Short Straddles

The straddle strategy is used by investors when they think the market will be volatile but know the direction. Straddle’s strategy helps them to hedge their investment in a volatile market.

The straddle strategy involves two trades in each long and short straddle.

Long Straddle consists of two trades in which investors expect the market will be highly volatile. In long straddles, traders trade on long calls and put both sides to maximize their profit.

Investors will hedge between a higher strike price and a lower strike price, so when the market’s volatile the price will be decided by the investor. Both sides’ investors will earn profit.

It should be considered that the stock price must move by more than 5-10% to mark profit. The investors will end up at a loss if the price is constant.

Short straddles are similar to long straddles, short straddles invest in low-volatility assets. The investor trades in low-volatility assets which is not highly fluctuating.

They purchase call and put options near the current spot price, and then they will only be able to earn if the assets do not move much and stay constant or below the strike price.

Merits and Demerits of Long and Short Straddle

MERITS	DEMERITS
1) This investment is based on the high volatility of the market.	If the market shows less movement then this strategy is of no use.
2)   Investors can gain huge profits with this strategy.	Investors will face losses, if the market is constant.

5) Long and Short Strangles

Strangles and straddles have a little difference. The Strangle investor uses a call and puts at a different strike price, while the straddle investor uses a call and puts with the same strike price.

In strangle, traders buy calls and put and sell with different strike prices with the same expiration date in the underlying asset.

Strangle strategy can be helpful if an investor thinks there will be high volatility in underlying assets shortly but not knowing the direction.

In long strangle, investors purchase an out-the-money call option with a price higher than the strike rate and buy an out-the-money put option with a lower price than the market price. In this case, investors will earn maximum profit from both sides. 

Short strangle is the same as long strangle only when it is profitable when the prices range at the breakeven points. The investor will sell an out-the-money put and an out-the-money call.

Merit and Demerits of Long and Short Strangle:

MERITS	DEMERITS
1) It has the benefit to sells at a different strike price within the same expiration date	Helpful only if the market is volatile in the underlying asset.
2)   If the market shows a predictable direction then investors can earn profit.	Investors can earn limited profit.

Conclusion

With the increase in investment options, people believing invest in the stock market, and with awareness of all the strategies traders can maximize their profit and limit their loss.

However, the market is never predictable and is volatile all the time. One can take a risk in the short term with precautions.These strategies are the precautions given to investors to enjoy the maximum profit and limit their losses with proper market understanding.