Knowing how to trade options can be one of the most profitable tools in your investing arsenal. That’s because options are cheaper to trade than buying the stocks directly. Plus, you can use some strategies — like selling covered calls — to earn passive income on the stocks you own.
Before we begin
Before we get into options strategies, it’s essential to understand these key terms you’ll encounter when trading options:
|In the money||Strike price is lower than the market price of the asset||Strike price is higher than the market price of the asset|
|At the money||Strike price is the same as the market price of the asset||Strike price is the same as the market price of the asset|
|Out of the money||Strike price is higher than the market price of the asset||Strike price is lower than the market price of the asset|
6 options strategies
Now that we’ve covered some of the common terms you’ll encounter, here are six options trading strategies you can use to turn a profit.
The covered call strategy is often used to earn extra money on the stocks you own by selling call options and collecting the premium.
For this strategy to work, you have to believe the stock won’t trade higher than your strike price — the price at which your call will be exercised — and you’ll have to be willing to sell your shares if the strike price is reached.
Trading the covered call strategy
- Purchase the stock. You don’t have to purchase it if you already own at least 100 shares. Options contracts typically have a contract multiplier of 100, so be prepared to purchase no fewer than 100 shares if you don’t have them.
- Sell a call option for that stock. Selling a call option means you are obligated to sell your shares at the strike price before the expiration date if exercised by the buyer.
- Collect the premium. Since you are selling the option, you collect the premium. To increase your chances of success — meaning collect the full premium and keep your shares — select an expiration date for the options contract at least one month in the future.
Covered call strategy example
Let’s say you own 100 Apple shares and the current market price is $150. Sell one call option with a strike price of $170 and an expiration date one month later.
Suppose the premium to sell this call option is $2 per share. As soon as you sell the call option, you get $200 in your account (100 shares x $2 premium per share).
There are three outcomes
- Apple stock doesn’t reach the strike price of $170 by the expiration date. The options expire worthless, and you keep the $200 premium and your 100 shares.
- Apple stock is close to reaching the strike price of $170. You buy back the option and pay a premium for that, say $1 per share for a total of $100. You keep the 100 Apple shares, but you don’t collect the full premium — $200 you got from selling the call minus the $100 you paid to buy it back. You can now sell another covered call and repeat the process.
- Apple stock price reaches the $170 strike price, and the options contract buyer exercises the option. You sell your 100 shares at $170 per share.
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The married put strategy, also known as protective put, is often used as an insurance policy to protect your account from larger losses.
Trading the married put strategy
- Purchase the stock. You don’t have to purchase shares if you already own at least 100. You need 100 shares for every options contract.
- Buy a put option for that stock. This means you get the right to sell your shares at a certain price, but not the obligation.
- Exercise your option. If the stock price goes down and reaches the strike price, exercise your put option. This will protect your account from further losses.
Married put strategy example
Suppose you have 100 Apple shares. There’s bad economic news that causes the stock market to retreat. To avoid huge losses to your account, you buy one put option for $2 premium per share ($2 x 100 shares = $200) with a strike price of $140 while the current market price stands at $150.
There are two outcomes
- You were wrong and the market pushes higher. The Apple stock price trades at $200 now. You let your option expire worthless and take a total loss of $200, which is the insurance, or premium, you paid for the option. This is offset by the gains you make with the share price.
- The stock moves lower and goes past the strike price of $140 to $120. You exercise your option and sell your shares at $140 each. In this case, your only loss is the $200 premium you paid for the put option, or $2 per share. If you didn’t have this insurance, your losses would be more than $20 per share.
How does the married put differ from a simple stop-loss?
If you set a stop-loss order at $140, your broker will execute the order as soon as the price is reached. You will sell your Apple shares and will no longer hold them. The downside in this situation is that the price may move higher, and you won’t have any shares to profit.
With a married put, you don’t have to exercise your option until the expiration date. This means you can see if the price goes lower or moves higher. If it moves higher, you get to keep your shares without exercising your option. If it moves much lower, you can sell them at the strike price and limit your losses.
The bull call strategy is used by investors who expect limited upside gains in a certain stock. This strategy requires two orders, known as legs, that are executed in one trade.
Trading the bull call spread strategy
- Find a stock you believe will rise in value.
- Open a spread order with a buy call option at one strike price.
- Add another leg by selling a call option at a higher strike price but with the same expiration date as the first call option.
Bull call spread strategy example
You want to buy Apple shares because you think the price will move higher. You open a spread order, which is a combination of two positions, where you buy one call option that gives you the right to buy 100 Apple shares at a $150 strike price.
The second leg is selling a call option, meaning you are obligated to sell your 100 Apple shares at a higher price than the one you bought them. The strike price is $155 in this example. For the first order, you have to pay a premium, say $2 per share, and for the second order you are collecting the premium, say $1 per share. This minimizes your cost for this options trade.
There are two outcomes
- Apple’s stock price moves higher. The price reaches the first option strike price of $150. This won’t trigger your trade if you entered the position as a spread. Finally, the price stands at $160 at the expiration date. Your trade is triggered, and you buy 100 shares at $150 and sell them at $155. You earn the difference between the price change and the premium you paid for the contract.
- Apple’s stock price moves lower. Your trades aren’t executed, and you only lose the amount you paid for the premium.
The bear put spread works just like the bull call spread, except you profit if the stock price drops.
Trading the bear put spread strategy
- Find a stock you believe will fall in value.
- Open a spread order where you buy a put option at one strike price.
- Add a second order where you sell a put option with a lower strike price but with the same expiration date.
Bear put options strategy example
You open a spread order on Apple stock, which is a combination of two positions. Your first leg is you buy one put option with a strike price of $150. This gives you the right to sell the stock at the strike price.
The second leg is you sell a put option with a strike price of $145. This means you’re obligated to buy back the same number of shares that you sell in the first position. You pay the premium when you buy the put options and collect the premium when you sell the put option.
Note: You don’t need to own Apple shares to sell them in this example. All you need is cash for the amount required to execute the trade. Your broker will hold this amount as collateral until the options contracts are exercised.
There are two outcomes
- Apple’s stock price moves lower. This is the ideal scenario. Suppose Apple’s stock price now stands at $140. You sell Apple shares at the $150 strike price and buy them back at the second strike price of $145. You pocket the difference minus the premium you paid.
- Apple’s stock price moves higher. In this case, your options contracts aren’t exercised and your options expire worthless. You’ve only lost the premium you paid to buy the put options contract.
This strategy aims to protect a stock you own from potential short-term loss. It’s a practical option for investors who feel unsure about the direction a stock is going to move.
Trading the protective collar strategy
- You must own at least 100 shares for each collar trade.
- Buy a put option with a strike price below the current stock price. This gives you the right to sell the stock at the strike price, which acts as a form of insurance from further losses. You pay a premium for this insurance.
- Sell a call option with a strike price above the current stock price and with the same expiration date. This means you are obligated to sell your shares at the price. Since you’re selling the option, you collect the premium, which offsets a large chunk of the premium you paid to buy the put option previously.
Protective collar options strategy example
You own 100 Apple shares you bought at $140, which is the current stock price. You buy a put option with a strike price of $135 for a $2 premium. This means you have the right to sell your shares at $135 if the stock price tanks. For this, you pay $200 — $2 premium per share.
At the same time, you sell a call option with a strike price of $150. This means that if the price reaches $150, you’ll have to sell your shares. What’s more, you collect a $1.50 premium for that.
There are two outcomes
- Apple’s stock price moves lower. The price dropped to $120. You decide to exercise your option and sell your shares at $135, thus limiting your losses.
- Apple’s stock price moves higher. At the expiration date, Apple’s stock price stands at $160. You were obligated to sell your shares at $150. In this case, you profit from the difference between the $140 for which you bought the shares and the $150 price at which you sold your shares. You’re also down $0.50 per share, the difference between the premium you paid and the premium you collected.
The long straddle options strategy is used when a trader isn’t sure whether the price of a stock will move higher or lower.
Trading the long straddle strategy
- Buy a call option.
- Buy a put option with the same strike price and expiration date as the call option.
Long straddle options strategy example
You buy an Apple shares call option with a strike price of $150. This gives you the right to buy 100 Apple shares at this price. You pay a premium of $2 per share for this options contract.
Now you buy an Apple shares put option with a strike price of $150 and the same expiration date as the call option. This gives you the right to sell 100 Apple shares at $150. You also pay a $2 per share premium for this options contract.
There are two outcomes
- Apple’s stock price moves lower. The price dropped to $120. You exercise your put option and sell 100 shares at the strike price of $150. Your call option, or the right to buy Apple shares, expires worthless. Your only cost, in this case, is the $4 per share premium you paid to buy both the call and the put contracts.
- Apple’s stock price moves higher. At the expiration date, Apple’s stock price stands at $170. You exercise your option to buy 100 Apple shares at the strike price of $150. Your cost in this case was also $4 per share you paid for both the call and the put contracts.
Trading options comes with fees. Choose a broker or a platform, such as Robinhood, with minimum or no fees to maximize your profit.
Information on this page is for educational purposes only. Finder is not an advisor or brokerage service, and we don't recommend investors to trade specific stocks or other investments.
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