As an options trader, you know that trading options requires advanced strategy knowledge. In fact, it can take years to understand the complexities of option trading. (Just remember that nobody was born knowing how to trade options — every great options trader had to learn from scratch.)
It’s important to have the right tools and insights to help you find appropriate option trades for just about any market outlook or environment. Whether you find yourself in a bearish, bullish, neutral, or volatile trading environment, we can offer resources to help you with your trading strategy.
Learn more: As Ally Invest’s resident option expert, I regularly host educational webinars on stocks, trading and options. Find out more about Brian Overby’s invest events.
In this article, we’ll stick to bullish and bearish strategies. We’ll explain bullish and bearish strategies at the basic levels, so you know how to implement them in your own trading.
- Bullish Option Strategies
- Buying a Call Option
- Buying a Protective Put
- Bearish Option Strategies
- Buying a Put Option
- Short Selling a Stock
- A Guide for Option Trading
Bullish Option Strategies
Investors generally use bullish trading strategies when they forecast an increase in a security’s price, which we often refer to as the “underlying price” or simply the “stock price.” When using a bullish trading strategy, it’s usually because an investor believes that these trades will result in a gain. Of course, if those projections do not perform as expected, the option trade may result in a loss.
Buying a Call Option
A call option provides you with the right to buy the underlying shares (usually 100 per contract) at a pre-negotiated price on or before a specific date. If the stock increases in price, the call option’s price may increase as well, which would lead to a profit. If the call option’s price increases above the amount paid, you’ll also realize a profit.
However, it’s possible for the call option to lose value, causing you to lose money. Too much time may have passed or a decline in the corresponding equity’s price may have occurred. If this happens, you may lose a portion of or the entire amount of the call option’s value.
Buying a Protective Put
If you own or are long 100 shares of a stock, you may decide to protect your investment during times of market uncertainty or increased market volatility.
If you have a bullish longer-term outlook, one option trading strategy to consider involves buying a put option online in order to protect or hedge the long stock position. The buyer of the put option obtains the right to sell the individual equity shares (usually 100 per contract) at a predetermined price on or before a certain date. This means that if the stock declines in value, the put buyer has the right to sell the shares for a potentially higher amount than the current stock price.
The put option is sort of like an insurance policy for a stock, and you pay for it using an option premium. You hope you never need to use it, but it’s nice to know you have it. Even though you “insure” your asset, there is no limit to the upside profitability of the stock if the stock increases by more than the cost of the put option. If the stock stagnates or only increases slightly, you may not have needed the put in the first place. In this situation, you may incur a loss on the put trade.
Bearish Option Strategies
Can you name one common bearish strategy most beginner online traders learn? It’s selling a stock short online.
When you expect the underlying stock price to move downward, you use bearish option strategies. In order to select the optimum trading strategy, you should assess how low the stock price can go and the timeframe in which the decline will happen.
If you foresee a decline in a stock’s value, you’ll likely employ a bearish options trading strategy that will take advantage of a decrease in the underlying asset’s price. This may cause the strategy to realize a gain. If your forecast is incorrect, you could net a trading loss.
Buying a Put Option
If you have the same market outlook as a short seller but prefer a trading strategy with lower and predefined risks, you can purchase a put option. Unlike the protective put strategy, you do not own the underlying stock.
As the buyer of a put option, you have the right to sell shares of the stock (usually 100 per contract) at a fixed price on or before the expiration of the put option contract. If the stock decreases, the put option may become more valuable as the stock trades lower and lower in price. This increase in the put option’s value allows you to sell the put option for more than you paid and you then profit from the sale.
You can lose money using this strategy if the put price declines in value or if the stock movement is opposite to your forecast and actually increases. Too much time may also pass. However, you limit your loss to the cost paid for the put option.
Read more: Put Options Explained
Short Selling a Stock
Selling a stock short online means that a stock declines in price lower than your sell short price. You buy back the shares that you are short and close out the short stock position. If the stock increases in price, you will incur incremental losses as the stock rises in price. However, because there is no limit on how high a stock may rise, short selling may result in unlimited losses.
A Guide for Option Trading
Option trading strategies aren’t black and white — you can run into numerous shades of gray as you look for the right approach.
Market-neutral option trading strategies attempt to take advantage of a stock expected to be range bound or stagnant in price over a period of time. Although any price movement is possible, it’s unlikely that a stock will move severely in either direction during orderly trading conditions.
You may foresee increased volatility in a certain stock. That’s when your strategy should maximize exposure to increased implied volatility in options. Increases in implied volatility infer that the stock has a greater propensity to move either up or down. You can use certain strategies to make a profit if the stock makes an extreme price move. If the stock stagnates or implied volatility decreases, you may experience a loss.
Option trading can feel like a lot to swallow, but if you take it one bite-size strategy at a time, you might find it easier to digest. Take it slow, do your research and add option trading to your strategy as you feel comfortable.
Ally Invest offers flexibility and customization in our platform, so you can add option trading to your investing strategy in a way that’s best for you.
As senior options analyst for Ally Invest, Brian Overby is a widely sought-after resource for his option trading knowledge and market insights. He has contributed to numerous articles for the Wall Street Journal, Reuters, and Bloomberg, and has had frequent appearances on CNBC Fast Money and Fox Business News. A veteran of the financial industry since 1992, Brian continually seeks to improve the understanding of the retail investor. He has given thousands of option trading seminars worldwide, written hundreds of articles on investing, and is the author of the popular trading resource The Options Playbook and its free, acclaimed companion site OptionsPlaybook.com. Prior to Ally, Brian was a senior staff instructor for the Chicago Board Options Exchange (CBOE) and managed the training department for one of the world’s largest market makers, Knight Trading Group.