Options Trading Strategies For Beginners

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Getting Started with Options Trading

Options are among the most popular vehicles for traders, because their price can move fast, making — or losing — a lot of money quickly. Options strategies can range from quite simple to very complex, with a variety of payoffs and sometimes odd names. Regardless of their complexity, all options strategies are based on the two basic types of options: the call and the put.

Understanding Call and Put Options

Before diving into the various options trading strategies, it’s essential to understand the basics of call and put options. A call option gives the buyer the right, but not the obligation, to buy a stock at a specified price (strike price) before a certain date (expiration date). On the other hand, a put option gives the buyer the right, but not the obligation, to sell a stock at a specified price (strike price) before a certain date (expiration date).

5 Options Trading Strategies for Beginners

Here are five popular options trading strategies, a breakdown of their reward and risk, and when a trader might leverage them for their next investment. While these strategies are fairly straightforward, they can make a trader a lot of money — but they aren’t risk-free.

1. Long Call

In this option trading strategy, the trader buys a call — referred to as “going long” a call — and expects the stock price to exceed the strike price by expiration. The potential profit on this trade is uncapped, and traders can earn many times their initial investment if the stock soars.

• Example: Stock X is trading for $20 per share, and a call with a strike price of $20 and expiration in four months is trading at $1. The contract costs $100, or one contract $1 100 shares represented per contract.
• Reward/Risk: The upside on a long call is theoretically unlimited. If the stock continues to rise before expiration, the call can keep climbing higher, too. The downside for a long call is a total loss of your investment — $100 in this example. If the stock finishes at or below the strike price, the call will expire worthless, and you’ll be left with nothing.
• When to Use: A long call is a good choice when you expect the stock to rise significantly before the option’s expiration.

2. Covered Call

A covered call involves selling a call option (“going short”) but with a twist. Here, the trader sells a call but also buys or owns the stock underlying the option, 100 shares for each call sold. Owning the stock turns a potentially risky trade — the short call — into a relatively safe trade that can generate income.

• Example: Stock X is trading for $20 per share, and a call with a strike price of $20 and expiration in four months is trading at $1. The contract pays a premium of $100, or one contract $1 100 shares represented per contract. The trader buys 100 shares of stock for $2,000 and sells one call to receive $100.
• Reward/Risk: The potential profit on the covered call is limited to the premium received, regardless of how high the stock price rises. Any gain that you otherwise would have made with the stock’s rise is completely offset by the short call. The downside is a complete loss of the stock investment, assuming the stock goes to zero, offset by the premium received.
• When to Use: A covered call can be a good options trading strategy to generate income if you already own the stock and don’t expect the stock to rise significantly in the near future.

3. Long Put

In this beginning option trading strategy, the trader buys a put — referred to as “going long” a put — and expects the stock price to be below the strike price by expiration. The potential profit on this trade can be many multiples of the initial investment if the stock falls significantly.

• Example: Stock X is trading for $20 per share, and a put with a strike price of $20 and expiration in four months is trading at $1. The contract costs $100, or one contract $1 100 shares represented per contract.
• Reward/Risk: The potential profit on a long put is almost as good as on a long call, because the gain can be multiples of the option premium paid. However, a stock can never go below zero, capping the upside, whereas the long call has theoretically unlimited upside.
• When to Use: A long put is a good choice when you expect the stock to fall significantly before the option expires.

4. Short Put

This options strategy is the flip side of the long put, but here the trader sells a put — referred to as “going short” a put — and expects the stock price to be above the strike price by expiration. In exchange for selling a put, the trader receives a cash premium, which is the most a short put can earn.

• Example: Stock X is trading for $20 per share, and a put with a strike price of $20 and expiration in four months is trading at $1. The contract pays a premium of $100, or one contract $1 100 shares represented per contract.
• Reward/Risk: The upside on the short put is never more than the premium received, $100 here. Like the short call or covered call, the maximum return on a short put is what the seller receives upfront. The downside of a short put is the total value of the underlying stock minus the premium received, and that would happen if the stock went to zero.
• When to Use: A short put is an appropriate strategy when you expect the stock to close at the strike price or above at expiration of the option.

5. Married Put

This strategy is like the long put with a twist. The trader buys the underlying stock and also buys a put for every 100 shares of the stock. This is a hedged trade, in which the trader expects the stock to rise but wants “insurance” in the event that the stock falls. If the stock does fall, the long put offsets the decline.

• Example: Stock X is trading for $20 per share, and a put with a strike price of $20 and expiration in four months is trading at $1. The contract costs $100, or one contract $1 100 shares represented per contract. The trader buys 100 shares of the stock at the same time and buys one put for $100.
• Reward/Risk: The maximum potential profit of the married put is theoretically uncapped, as long as the stock continues rising, minus the cost of the put. The married put is a hedged position, and so the premium is the cost of insuring the stock and giving it the opportunity to rise with limited downside.
• When to Use: A married put can be a good choice when you expect a stock’s price to increase significantly before the option’s expiration, but you think it may have a chance to fall significantly, too.

Key Takeaways

Picking the right options trading strategy for you will depend on what direction you think a stock’s price will go and your capacity to absorb losses. Buying an option, or “going long,” will have less risk than selling, or “shorting,” one, since your potential loss is capped at its premium while your gains could be unlimited. You can incorporate stocks you already own into your options trading plan.

• Summary: The five options trading strategies for beginners are long call, covered call, long put, short put, and married put. Each strategy has its unique reward and risk profile, and traders should choose the one that best suits their investment goals and risk tolerance.
• Investment Minimums: If you’re looking to trade options, the good news is that it often doesn’t take a lot of money to get started. However, it’s very easy to lose your money while “swinging for the fences.” A safer strategy is to become a long-term, buy-and-hold investor and grow your wealth over time.

Getting Started with Options Trading

To start trading options, you’ll need to find a broker that offers options trading and then enable that feature on your account. You’ll need to answer a few questions about what kind of options trading you want to do, because some options strategies (such as selling puts and calls) have different risks from others, and you could lose more money than you put into the trade.

• Broker Requirements: The requirements for options trading may differ at each broker — and some brokers don’t offer it at all — so you’ll need to investigate what each requires if you decide to enable that feature.
• Investment Apps: Even many of the best investment apps offer options trading, so you won’t have too much trouble gaining access.

Conclusion

While options are normally associated with high risk, traders can turn to several basic options trading strategies that have limited risk. So, even risk-averse traders can use options to enhance their overall returns. However, it’s always important to understand the downside to any investment so that you know what you could possibly lose — and whether it’s worth the potential gain.

As you begin your options trading journey, remember to always keep your investment goals and risk tolerance in mind. With the right strategy and a solid understanding of the options market, you can unlock the full potential of options trading and achieve your financial goals. So, take the first step today, and start exploring the world of options trading!

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