Understanding upside opportunities in options trading
There are plenty of upside opportunities in options trading if you know the right option strategy. In this blog, we will talk about the lesser-known lucrative prospects of options trading and how you can make the most of them.
Options trading is gaining popularity, and it's clear why. It offers a chance to make huge profits. With options, you can protect yourself from losses in other financial investments such as stocks, bonds, mutual funds, and so on. Plus, you don't need as much money to start with options as you do with, say, stocks or real estate. This makes it a more affordable choice for many. The best part is that options work in all market situations, whether the stock market is bullish, bearish, or sideways.
But let's be honest, for those of us who are new to it, options can seem a little complicated. However, once you understand the basics, the opportunities to earn become more obvious.
In this blog, we'll introduce you to less familiar rewarding sides of options trading and talk about some standard option strategies to boost your returns.
How do options offer upside opportunities?
When we say "upside opportunities" in options trading, we're referring to the potential for profit that arises from favourable price movements in the market. Essentially, it's the chance to make money when things go in the direction you've predicted.
Options stand out from other financial instruments in several ways:
- Flexibility: Options let traders profit from price increases with calls and from price decreases with puts. This gives more ways to earn.
- Lower initial investment: Buying options cost less than buying stocks directly. This smaller initial payment is known as the premium and can lead to higher returns relative to the amount invested.
- Defined risk: The most a buyer can lose is the premium paid. This clarity helps traders know their potential losses from the start.
- Diverse strategies: Traders can mix and match options to create strategies that fit different market views and risk levels.
- Leverage: Traders can control a larger position with a relatively small amount of money by increasing potential profits.
- Protection: Options can act like insurance for a stock portfolio, and guard against unwanted price movements.
Option strategies to tap into upside opportunities
When we talk about the stock market, there are several strategies traders use to make the most of potential profit chances. Here's a simple breakdown of some popular option strategies that can help you tap into these opportunities:
You buy the asset (stock, commodity, currency, or index) and then sell a call option for it. This approach gives you some extra cash from the option's premium and offers a safety net if the asset's value drops. However, if the asset's price soars, your profit is capped by the call option's set price.
Bull call spread
You purchase a call option at a set price and sell another at a higher price for the same asset. This reduces your initial cost but also limits your top profit to the gap between the two prices. It's best when you think the asset will rise, but not by a massive amount.
Call ratio back spread
Here, you sell a call option at one price and buy more call options at a higher price for the same asset. You start with some credit, and if the asset price shoots above the higher option price, there's no limit to your potential profit. It's a strategy for when you're feeling very bullish about an asset.
You buy both a call and a put option at the same price for an asset. This means you can profit if the asset price moves significantly, up or down. It's a bit pricey to start, and you need a big price swing to break even. It's for times when you're unsure which way the market will swing.
Similar to the straddle, but you buy the call and put options at different prices. This costs less upfront but needs a bigger price move in either direction to see profits. It's for when you expect high volatility.
Long call butterfly spread
You buy a call option at one price, sell two at a middle price, and buy another at a higher price. All for the same asset. You pay a bit to enter this trade, and your potential profit and loss are both limited. You'll see the most profit when the asset price matches the middle option price at its expiry. It's a strategy for when you think the asset price will stay steady or rise just a bit.
Long call condor spread
A bit like the butterfly spread, but with four different option prices. You start with a small debit, and both your potential profit and loss are capped. The maximum profit comes when the asset price lands between the two middle option prices when they expire. It's for when you're feeling a bit bullish about an asset.
Wrapping up: Key points to remember
- Options let you trade a wide range of assets with a small investment. However, this can lead to both significant profits and losses.
- It is important to close out your option position before the expiration date or you will lose all of your investment.
- Options are complex instruments, and there are many different strategies that you can use. It is important to understand the risks and rewards of each strategy before you trade.