Options trading is a popular form of investing in Australia. This type of trading allows investors to speculate on the future direction of a stock’s price, without owning the underlying asset. There are a variety of options trading strategies that investors can use to achieve their investment goals.
In this article, we will look at 5 intermediate options trading strategies that traders may want to try out the next time they participate in the market. But before that, we will explain what options trading is exactly, and how it is regulated in Australia.
What is options trading?
Options trading is a form of investment that allows traders to buy or sell an asset at a predetermined price within a specific timeframe. It provides the trader with the flexibility to speculate on the movement of prices without owning the underlying asset. When trading, the option holder has the right, but not the obligation, to buy or sell the asset at the agreed-upon price.
Is options trading regulated in Australia?
The Australian Securities and Investments Commission (ASIC) oversees all types of financial trading in the country. Before trading options, investors should do their research and understand the risks involved. Options trading can be a high-risk, high-reward form of investing, and investors should be prepared to potentially lose their entire investment. However, with careful planning and risk management, options trading can be a valuable addition to an investor’s portfolio.
5 intermediate options strategies
Now that we have gone through the basics, it is time to look at the strategies that intermediate options traders can use when they want to kick their trading up a notch. They are the covered call, the protective put, the iron condor, the straddle, and the strangle.
The covered call
A covered call is an options trading strategy where the trader holds a long position in an asset, such as a stock, and sells call options on that same asset. The trader collects the premium for selling the call option and can potentially earn additional income if the price of the underlying asset stays below the strike price of the call option.
If the price of the underlying asset rises above the strike price, the trader may be obligated to sell the asset at the lower strike price, which can limit potential profits.
Investors use covered calls in options trading to generate income by selling call options on securities that they already own. This means they use this strategy when they are neutral or slightly bullish on the underlying security, as the strategy can limit potential gains but can also help to protect against potential losses. They also find the strategy most effective in a stable or slightly rising market environment.
The protective put
A protective put is a risk management strategy that involves purchasing a put option to protect a long stock position. It provides downside protection in case the stock price drops, limiting the potential loss.
If the stock price falls, the put option will increase in value, offsetting some or all the losses from the long stock position. This strategy is commonly used by investors who hold a long-term bullish outlook but want to protect against potential short-term volatility.
Traders use protective puts in options trading to limit their potential losses if the price of the underlying asset falls, because it allows them to sell the asset at the strike price of the put option if the market price falls below the strike price. In other words, they use this strategy when they have a long-term bullish outlook on the underlying asset but want to protect their position in case of a short-term market downturn.
The iron condor
The iron condor is an options trading strategy that involves selling both a put spread and a call spread with the same expiration date but different strike prices. This strategy is typically used when an investor believes that the underlying asset will remain within a certain price range.
Traders can achieve the maximum profit for this strategy if the price of the underlying asset remains between the two spreads. However, if the price of the underlying asset moves outside of the spread, losses can be substantial.
Traders use the iron condor in options trading to earn income through a neutral trading strategy. They typically use it when they expect a stock or index to trade in a narrow range for a period.
A straddle is a strategy that involves buying both a call and a put option with the same strike price and expiration date. This allows the trader to profit from significant price movements in either direction, as they have the right to buy or sell the underlying asset at the same price regardless of whether it moves up or down. The maximum loss in a straddle is limited to the initial cost of purchasing the options, making it a popular choice for traders looking to manage risk.
This strategy can be particularly useful during periods of high market volatility, as it provides a way to potentially profit from significant price movements without having to predict the market direction. Therefore, traders may use the straddle strategy when they anticipate a significant move in the price of an underlying asset but are unsure about the direction.
Finally, a strangle is a strategy that involves buying or selling both a call and a put option on the same underlying asset with the same expiration date but with different strike prices. Traders use this strategy when they expect a significant price movement in the underlying asset but are uncertain about the direction of the movement. By buying both a call and a put option, they can potentially profit from a large price move in either direction.
Just like the straddle, the strangle is a perfect strategy for traders to execute during periods of high market volatility. That is because it also provides a way for traders to potentially benefit from significant price moves in either direction, meaning they do not have to be entirely certain which way the market will move to find opportunities.
Which options strategy should I use?
The options trading strategy that you should use depends on a variety of factors, including your risk tolerance, investment goals, and the specific market conditions you are trading in. Therefore, it is exceedingly important to do your research and understand the different options strategies available, as well as the potential risks and rewards associated with each.
However, some popular options strategies discussed above can be used in these market conditions:
- Covered calls: for a bullish or neutral market
- Protective puts: for a bearish or neutral market
- Iron condor: for a market with low volatility
- Straddle and strangle for a market with high volatility
In conjunction with trading strategies, you should also make sure you understand as much as you can about options trading and the markets in which you participate. This can give you greater insight into how you can navigate moments of volatility, so you can make more informed trading decisions.
Finally, it is important to remember that options trading can be complex and involves risks, so it’s a good idea to consult with a financial advisor or professional before making any investment decisions, regardless of your skill level as a trader.