Over the last few years, there has been a significant rise in the number of people involved in futures and options trading in India. Through option trading, you can buy or sell an underlying asset at a fixed cost sometimes in the future. Unlike futures, where both parties need to mandatorily fulfil contractual obligations, option trading has no such obligation. That said, there are several option trading strategies that you can incorporate depending on market conditions. What are these? Let us find out.
Different Types of Option Trading Strategies
The various kinds of share market strategies you can deploy while getting involved in options trading are as follows:
Bullish Option Strategies
A bullish option trading strategy is the one that you deploy if you feel that the cost of the underlying asset will go north by the expiry date. The bullish stock trading strategies include:
Long Call
The long call strategy is one of the foremost bullish option trading strategies that involves buying a call option. Suppose you are interested in purchasing a call option on the stock of a company currently trading at ₹100 per share.
You buy a call option at the strike price of ₹110 with an expiration date of 1 month from now. The lot size is 100 shares, as options are sold in lots, and the premium you pay is ₹5 per share. Suppose the stock price rises to ₹130 before the expiry date. As you have the call option, you have the right to buy the shares at ₹110, with your profit standing at ₹15 per share, excluding the premium.
Bull Call Spread
It is one of the most widely used share market strategies in option trading when markets are expected to go up. In this strategy, you purchase a call option at a lower strike price and sell another call option at a higher price. Suppose the stock of a certain company is currently trading at ₹100, and you expect the price to rise. You purchase a call option at a strike price of ₹90 by paying a premium of ₹8.
You simultaneously sell the call option at a strike price of ₹120 for a premium of ₹3. If the stock price rises to ₹120, the profit you earn is the difference between strike prices minus the premiums paid.
Bull Put Spread
You can use the bull put spread if you expect a moderate price rise. Suppose you assume that the stock currently trading at ₹200 will either rise or stay above ₹190 in the next month. You decide to utilise a bull put spread by selling a put option at a strike price of ₹190 and buying a put option at a strike price of ₹180, with the same expiration date.
If the stock price stays above ₹190, both put options become worthless. On the other hand, if the stock price drops below ₹180, both put options will be exercised, and the loss on the sold put option will be offset by the gain on the put option purchased.
Bearish Option Trading Strategies
Contrary to bullish option trading strategies, bearish option trading strategies come to the fore when you expect a decline in underlying asset’s price by the expiration date. The bearish share market strategies include:
Bear Put Spread
The bear put spread is a stock strategy that involves buying a put option at a higher strike price and selling another put option at a lower strike price. This strategy aims to limit losses and reduce the cost of buying the put option. Suppose a stock is trading at ₹ 150, and you expect its price to drop.
If you purchase a put option at a strike price of ₹160 for a premium of ₹ 10 and sell a put option at a strike price of ₹140 for a premium of ₹4. If the stock price falls to ₹140 by expiration, you have the right to exercise the higher-priced put option. You profit from the difference between strike prices, excluding the premiums paid.
Bear Call Spread
In this option trading strategy, you sell a call option at a lower strike price and buy another call option at a higher strike price.
For example, if a stock is trading at ₹200, you might sell a call option at a strike price of ₹210 for a premium of ₹6 and buy a call option with a ₹220 strike price for a premium of ₹3. If the stock price remains below ₹210 at the expiry date, both options become worthless, and you keep the net premium of ₹3 as profit. On the other hand, if the stock rises above ₹220, your losses are limited to the purchased call option.
Neutral Stance Option Trading Strategies
Neutral stance option trading strategies are plans you implement when you are pretty confident that the underlying asset’s price will stay within a particular range. The various types of neutral option trading strategies are as follows:
Short Straddle Option Trading Strategy
This trading strategy is where you sell a call option and put an option with the same strike price and expiration date. For example, if a stock is trading at ₹200, you sell a call and put option with a strike price of ₹200. If the stock’s price remains close to ₹200 at the contract’s expiry date, you are set to make a profit. On the other hand, if the price moves up or down, you can face significant losses.
Short Strangle Trading Strategy
In the short strangle trading strategy, you sell a put option and then sell a call option at a higher similar. Similar to the short straddle strategy, the premiums earned are your gains, and you retain the profit as long as spot prices remain within a particular range.
Best Strategy for Option Trading
There is no single strategy that can claim to be the best share market strategy in option trading. It depends primarily on your goals and market dynamics. You can use one or a combination of the above-mentioned trading strategies to go ahead with options trading after you open Demat account.
Wrapping It Up
While an option trading strategy can help you get going, it is vital to understand the nitty-gritty of this form of trading, which involves high risk. With HDFC SKY, a share trading app, you can kick-start your investment journey in option trading. That is not all.
As per your goals and risk tolerance, you can invest in stocks, mutual funds and initial public offerings (IPOs) with this F&O app and embark on your path to financial freedom.
