### Trading Stock Options: Basic Option Trading Strategies and How to Use Them to Profit in Any Market

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An example of a married put would be if an investor buys shares of stock and buys one put option simultaneously. This strategy is appealing because an investor is protected to the downside should a negative event occur. At the same time, the investor would participate in all of the upside if the stock gains in value. The only downside to this strategy occurs if the stock does not fall, in which case the investor loses the premium paid for the put option.

With the long put and long stock positions combined, you can see that as the stock price falls the losses are limited. Yet, the stock participates in upside above the premium spent on the put. Both call options will have the same expiration and underlying asset. The trade-off when putting on a bull call spread is that your upside is limited, while your premium spent is reduced. If outright calls are expensive, one way to offset the higher premium is by selling higher strike calls against them. This is how a bull call spread is constructed. In this strategy, the investor will simultaneously purchase put options at a specific strike price and sell the same number of puts at a lower strike price.

## Basic Option Trading Strategies You Can Use to Make Money...

Both options would be for the same underlying asset and have the same expiration date. This strategy is used when the trader is bearish and expects the underlying asset's price to decline. It offers both limited losses and limited gains. The trade-off when employing a bear put spread is that your upside is limited, but your premium spent is reduced.

If outright puts are expensive, one way to offset the high premium is by selling lower strike puts against them. This is how a bear put spread is constructed. This strategy is often used by investors after a long position in a stock has experienced substantial gains. This is a neutral trade set-up, meaning that you are protected in the event of falling stock, but with the trade-off of having the potential obligation to sell your long stock at the short call strike.

Again, though, the investor should be happy to do so, as they have already experienced gains in the underlying shares. This strategy allows the investor to have the opportunity for theoretically unlimited gains, while the maximum loss is limited only to the cost of both options contracts combined.

This strategy becomes profitable when the stock makes a large move in one direction or the other.

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An investor who uses this strategy believes the underlying asset's price will experience a very large movement, but is unsure of which direction the move will take. This could, for example, be a wager on an earnings release for a company or an FDA event for a health care stock.

Losses are limited to the costs or premium spent for both options. This strategy becomes profitable when the stock makes a very large move in one direction or the other. All of the strategies up to this point have required a combination of two different positions or contracts. All options are for the same underlying asset and expiration date.

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For example, a long butterfly spread can be constructed by purchasing one in-the-money call option at a lower strike price, while selling two at-the-money call options, and buying one out-of-the-money call option. A balanced butterfly spread will have the same wing widths. If the Black Scholes model is correct, it would mean that the underlying follows a lognormal distribution and the implied volatility curve would have been flat, but a volatility smile indicates that traders are implicitly attributing a unique non-lognormal distribution to the underlying.

This non-lognormal distribution can be attributed to the underlying following a modified random walk, in the sense that the volatility is not constant and changes with both stock price and time. In order to correctly value the options, we would need to know the exact form of the modified random walk. More specifically a unique binomial tree is extracted from the smile corresponding to the random walk of the underlying, this tree is called the implied tree.

This tree can be used to value other derivatives whose prices are not readily available from the market - for example, it can be used in standard but illiquid European options, American options, and exotic options. Steven Heston provided a closed-form solution for the price of a European call option on an asset with stochastic volatility. This model was also developed to take into consideration the volatility smile, which could not be explained using the Black Scholes model. The basic assumption of the Heston model is that volatility is a random variable. Therefore there are two random variables, one for the underlying and one for the volatility.

Generally, when the variance of the underlying has been made stochastic, closed-form solutions will no longer exist. But this is a major advantage of the Heston model, that closed-form solutions do exist for European plain vanilla options. This feature also makes calibration of the model feasible.

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## Options Trading Explained - Free Online Guide to Trading Options

If you are interested in learning about these models in more detail, you may go through the following research papers,. So far, you have understood options trading and how to analyse an option as well as the pricing models used. Now, to apply this knowledge, you will need access to the markets, and this is where the role of a broker comes in.

Once the required background research is done, you can choose the right broker as per your need and convenience. In the global market, a list of the top brokers is provided below:. The list of top Indian options brokers is given below:. One of the most popular options trading strategies is based on Spreads and Butterflies. Spreads or rather spread trading is simultaneously buying and selling the same option class but with different expiration date and strike price.

Spread options trading is used to limit the risk but on the other hand, it also limits the reward for the person who indulges in spread trading. Thus, if we are only interested in buying and selling call options of security, we will call it a call spread, and if it is only puts, then it will be called a put spread. Depending on the changing factor, spreads can be categorised as:. Thus, we can also distinguish an option spread on whether we want the price to go up Bull spread or go down Bear spread.

In a bull call spread, we buy more than one option to offset the potential loss if the trade does not go our way. The following is a table of the available options for the same underlying stock and same expiry date:. You can go through this informative blog to understand how to implement it in Python. The bull call spread was executed when we thought the stock would be increasing, but what if we analyse and find the stock price would decrease. In that case, we use the bear put spread.

Thus, we create a scenario table as follows: In this way, we can minimize our losses by simultaneously buying and selling options. A butterfly spread is actually a combination of bull and bear spreads. One example of the Butterfly Options Strategy consists of a Body the middle double option position and Wings 2 opposite end positions.

We have covered all the basics of options trading which include the different Option terminologies as well as types. We also went through an options trading example and the option greeks. We understood various options trading strategies and things to consider before opening an options trading account. Disclaimer: All data and information provided in this article are for informational purposes only. All information is provided on an as-is basis. What is options trading? Options trading vs. Stock trading Options terminologies Types of options Options trading example What is put-call parity in Python?

Stock trading There must be a doubt in your mind that why do we even have options trading if it is just another way of trading. Well, here are a few points which make it different from trading stocks The Options contract has an expiration date, unlike stocks. The expiration can vary from weeks, months to years depending upon the regulations and the type of Options that you are practising.

## Option (finance)

Stocks, on the other hand, do not have an expiration date. Options terminologies Strike Price The Strike Price is the price at which the underlying stocks can be bought or sold as per the contract. Underlying Asset In options trading, the underlying asset can be stocks, futures, index, commodity or currency. Expiration Date In options trading, all stock options have an expiration date. Options Style There are two major types of Options that are practised in most of the options trading markets.

When is an Option in-the-money? Call Option - when the underlying stock price is higher than the strike price Put Option - when the underlying stock price is lower than the strike price When is an Option out-of-the-money?

Call Option - when the underlying stock price is lower than the strike price Put Option - when the underlying stock price is higher than the strike price When is an Option at-the-money? When the underlying stock price is equal to the strike price. Take a break here to ponder over the different terms as we will find it extremely useful later when we go through the types of options as well as a few options trading strategies. Type of options In the true sense, there are only two types of Options i. Short call - Here we are betting that the prices will fall and hence, a short call means you are selling calls.

What does an options trading quote consist of? The symbol and option number is the first column.

### Options Trading Strategies for Beginners, No. 3: LEAPS

Here the volume is 0. Options Trading Example We will go through two cases to better understand the call and put options. The principle of put-call parity Put-call parity principle defines the relationship between the price of a European Put option and European Call option, both having the same underlying asset, strike price and expiration date. Required Conditions For Put-call Parity For put-call parity to hold, the following conditions should be met.

Arbitrage Opportunity In options trading, when the put-call parity principle gets violated, traders will try to take advantage of the arbitrage opportunity. How to take advantage of arbitrage opportunity Let us now consider an example with some numbers to see how trade can take advantage of arbitrage opportunities. Short the stock. Short the put option.

Purchase the call option.