Skip to main content

Types of Options Trading

Options trading is a versatile investment tool that allows investors to speculate on the price movement of various assets, including stocks, indices, and commodities. With options, traders can enjoy limited-risk trades, generate income through selling premium, or hedge against potential losses in their existing portfolio. There are several types of options trading strategies, each with its unique characteristics and risks.

Calls and Puts​

Calls and puts are the most basic forms of options trading. A call option gives the buyer the right to purchase an underlying asset at a predetermined price (strike price), while a put option allows the buyer to sell the asset at the same strike price. These options can be used for various purposes, such as speculating on market trends or hedging against potential losses.

Long and Short Options​

Trading long options involves buying calls or puts in anticipation of a price increase or decrease. In contrast, short options involve selling calls or puts with the expectation that the buyer will not exercise them, allowing the seller to keep the premium as profit. However, if the option is exercised, the seller must deliver the underlying asset at the strike price.

Spreads and Straddles​

Spread trading involves buying and selling options simultaneously, where the gains from one side offset potential losses on the other. A bull call spread, for instance, consists of buying a call option with a lower strike price and selling an identical call option with a higher strike price. This strategy allows traders to benefit from price increases without committing to the full cost of the underlying asset.

Strangles​

A strangle is similar to a spread, but it involves buying options at different strike prices rather than identical ones. A bear put spread and bull call spread are examples of this strategy, where the trader expects a significant price drop or rise, respectively.

Covered Calls​

This strategy involves selling calls on existing assets held in a portfolio. The benefit lies in generating additional income while limiting potential gains through the sale of shares at the strike price if exercised. However, selling covered calls reduces the upside potential of the underlying asset.

Iron Condors and Butterflies​

These strategies involve buying and selling options at various strike prices to create a range-bound position. Iron condors, for example, consist of buying puts with lower strike prices, selling puts with higher strike prices, selling calls with higher strike prices, and buying calls with lower strike prices. This complex strategy requires precise market prediction skills.

Other Types​

Besides the strategies mentioned above, other forms include Collars, which involve a combination of covered calls and protective puts to create a range-bound position; Synthetic Options, which replicate the behavior of real options through trading various assets in conjunction; and Options on Options, where traders buy or sell contracts that grant the right to buy or sell existing options.