Choosing an Option Strategy

When choosing an option strategy, the first question to ask is: what are my goals? In options trading there can be several goals. For example, if you are interested in trading stock options, your goals may be one or more of the following.

• Benefit from anticipating that a stock price is going to increase or decrease but without actually buying the stock
• Cover for potential stock losses on stocks currently held as the market declines
• Try to buy stock at a lower price because you believe the price will go down
• Enhance the income you are earning on the stock currently held
• Prepare for major market moves

So in other words you may want to take advantage of a bull or bear market, or you might want to hedge against losses. You also might want to maximize income.

The option strategy you choose will impact your probability of successfully reaching those goals. Traders can generally be classified into two types which are speculators and hedgers. Speculators are more willing to take risk because they are anxious to generate quicker income. Hedgers are more interesting in protecting investments. Hedgers are more in a mode of preventing loss rather than generating gain.

Don’t misunderstand though – all option traders want to make money. That’s why they invest in the options market. But the strategies chosen to reach goals can vary widely. The goal is to let the winning trades become as profitable as possible while cutting the losing trades off as soon as it is discovered they are losers. Eventually you will learn how to calculate your percentage of success based on the successful and unsuccessful trades you make.

Strategies can be very simple lie buying a call option or a buying a put option. But many of the strategies involve many more steps and are delicately balanced sets of transactions involving calls and puts with a variety of strike prices, expiration dates and even underlying assets. Following are some of the more common strategies that can be used to meet different investment goals. This list does not include all the possible strategies though because people develop new ones all the time as they gain trading experience.

Goal: Income

• Covered calls
• Sell naked calls or puts
• Condors
• Credit Spreads

Goals: Take Advantage of Rising Market

• Buy calls
• Bull call or put spreads
• Sell naked puts

Goal: Hedging

• Collars
• Married puts
• Protective puts

Goal: Take Advantage of Falling Market

• Buy puts
• Bear call or put spreads
• Sell naked calls

You can even choose strategies for a stagnant market. For example, if the market is neutral, you might want to choose the straddle option strategy. This strategy lets you anticipate a market move in either direction and limits risk either way. Other stagnant market strategies include strangles, ratio spreads and reversals.

If you have gotten the idea that options investing is complex then you are right. Yet you do not have to start your investing career in options by choosing the most complicated option strategy. Instead you can start with an easier strategy and then gradually progress into more advanced strategies.

Before option investing, first choose your goal and then match the strategy to that goal. With each investment the goal can change…but so can the strategy!

Related posts:

• The Covered Call Stock Option Strategy
• A Basket of Strategies Options Traders Utilize
• Basics of the Butterfly Option Strategy
• Common Option Strategies Tested in the Marketplace
• The Covered Call Options Strategy
• Choosing Options for Your Investment Portfolio