How to choose the Right Options Strategy? – Factors, Tools & moreLast Updated Date: Nov 17, 2022
Learn how to choose a right options strategy given the market condition & many other factors here.
Whilst the word on the street might go through series of changes, and recommendations about choosing a particular strategy could be pouring in, being well read will take you to the end of investment, where profit making will become a tradition.
Knowledge of every aspect of options trading is essential. You must start with gaining the insights about the basics of options trading, trading plan, finding rewarding trades, choice of stock broker and other similar things.
Well, you can always be well accustomed with just the theory, the real catch in related to strategy implementation.
Why Choose a Particular Options Strategy?
Options Trading is all about making the right decision by implementing correct strategy & the proficiency you managed to gain.
This makes it crucial to know what to apply in practical and find the space which will grant you highest return.
You must devise a plan and action. Among the constituents of the plan, the toughest part is selection a strategy to abide with.
No strategy is the go to strategy, which would be suitable for any given circumstances. The ranging factors which determine the suitability of a strategy for a certain investor and a certain circumstance are many.
Put in simple words, strategy which might seem right for a particular situation and person can be completely wrong for another.
Selecting the right options strategy can be a challenge for the newbie traders of options. This is however something which can be mastered along with time. This is also a matter of fact that professionals also have a hard time selecting strategies at time.
We do not mean to give the readers the go to strategies as per certain circumstance, and this article is no quick fix.
All we tend to do is, provide you the right information, following which you can go through the process of decision making.
We basically aim to educate you about the items you must consider, which will help you choose the appropriate strategy.
No investor started out as a pro in the industry, and hence, we urge you practice which will eventually lead you to a level of expertise.
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Perception of an investment
This includes how an investor perceives an investment option as, i.e. what he/she expects will happen to the option.
The major and easily described circumstances are, the traders think the price of security will fall or if it will rise. Rise in price or fall in price is generally a thing for a lot of instruments.
However, as far as options trading is of concern, there are four outlooks for it. The first being bullish – where the prices rise, then we have bearish – where the prices fall, following this we have neutral – where prices do not move or are generally stable, and lastly volatile – where high amount of price fluctuation is expected.
Now, you might thing options trading is complex, but the fact cannot remain hidden that so are your profit making possibilities massive.
There are massive amount of strategies available with options trading and they help you yield profit according to outlook.
Traders can further sub categorize these outlook in order to break down the aspects of situation and pick up on the most appropriate strategy.
Also, there is a possibility of outlook combination. One such instance is when a trader expects the price to be neutral in short term, but rise in long term.
There also exist such strategies which let you invest according to this kind of perception. Majorly, the options strategies are flexible in nature, however, you need to be assured of your outlook.
Risk and Reward Expectation
Risk is highly present in options trading as well, just like any other security. Trader must know the art of managing the risk, and it is part of the strategy selection procedure.
There are specific risk profile tagged to strategies, such as unlimited risk or certain maximum loss.
Here you must be well aware of the profile which is best suitable for you. To determine the same, you must consider the risk to reward ratio, which signifies the possible profit or loss.
Specified Positions and Spreads
Strategizing option investment basically means that an investor can also create spreads. In fact, a lot of options trading strategies comprise of spread, i.e. combining multiple positions to earn profits.
Speaking about perks of creating spread, it limit risk, reduces the upfront cost paid to take a position, a simultaneously take a position which has many more than one outcome tagged to it.
This makes it superior to taking a single spread, as the profit earning potential is limited in single position.
Single position simple comprises of either buying an options contract or simply writing an options contract.
Single position as well has a considerable amount of perks tagged to it. Also, there are more factors you must know, which are closely related to such positions.
Premium paid in single position is fewer as compared to spread, as spreads comprise of a lot of position. Each position adds on to the sum of premium paid in total.
There are also situations where spreads limit profit earning to an extent, but single positions take it above par.
This conveys the message that – spreads are possibly better for a lot of circumstance. However, there are certain situations when single positions yield high profits.
Level of expertise
When you open an account with a broker, to trade in options, they will designate a trading level to your account.
The level defines you level of expertise, following which be permitted to use specified strategies. Brokers take into account the trader’s risk profile and expertise and put a barrier on the strategies they chose accordingly.
If you have a low level trading account, you will be permitted to use only specific strategies. However, if you are on high level, you will be permitted to use complex strategies as well, since you will be better at risk management.
Risk is the sole reason why brokers designate levels, in order to protect their customers and themselves.
Complexity of Strategy
There are many levels of complexities, and a lot of strategies are classified into those levels.
There are strategies that are relatively simple and straightforward, and beginners are as well permitted to use them. Such simple strategies comprise of maximum 2 transactions.
Then, there are strategies which are on the higher scale of complexity, as they include taking three or more transactions.
This makes it really important for the traders to consider, as a complex strategy is generally difficult to execute, following which the traders may not be able to reap the exact benefits of the strategy.
We have already mentioned that higher number of transaction will attract higher premium, which will push up the commission you pay to broker. This as well hampers your profit making capacity as the expenses run higher.
Feasibility in many terms is provided by brokers, as there are a lot of brokers who provide easy investment function.
They provide their investors with the options, where selecting the strategy is all you need to do, and the transactions will automatically take place post the command.
Well, if traders choose legging, they will have to place each and every transaction at likely points. This might be complex, but is profitable in its own way, where choice of timing must be appropriate.
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Tools for choosing Right Options Strategy
Though flexible, it is surely difficult to select a particular strategy of options investment.
The flexibility factor in options trading expand your horizons of profits, it is because you do not only need to rely upon rising and falling prices. You can equally benefit from a neutral market condition, in options trading.
Some of the outlooks which are equally profitable are neutral prices, volatile prices, large and small price movement. There are more than these outlooks and this is a massive perk provided in options trading.
Well, as far as the strategies are of concern, there is never a right strategy to a particular situation, as there arises factor of individual investor’s attitude, which ranges from one trader to another. The ranging factors are risk profile aspired, individual objects and perceptions.
Here is out list of tool, which makes your selection of strategies easy. You can find strategies suitable for multiple outlooks.
The categorization is done on the basis of 4 outlooks – rising prices, falling prices, stable prices and volatile prices.
Moderate Rise in a Share Price – Options Strategy in Bull Market Scenario
In this outlook, the trader expects the price to increase, but not by a wider margin. The recommended Options Strategy for this outlook are:
Bull Call Spread – Perks in this strategy are reduced upfront cost in comparison to buying calls, whereas cons are limited profit when prices rise significantly.
Bull Put Spread – Perks in this strategy are – profits can also be made on account of no rise in price. Cons in this strategy are limited prices on account of significant rise in price.
Short Put – Perks in this strategy are that, this strategy is simple and has only one option, also reducing the premium cost. Cons in this strategy are possibility of loss if the prices fall.
Significant Rise in Share Price – Options Strategy for Bull Market Scenario
In this outlook, the trader expects the price to increase significantly. We recommended the following strategies for this outlook:
Long Call – Perk in this strategy is no limit on profits possibility. Con in this strategy is lack of protection on account of falling prices or no mobility.
Short Bull Ratio Spread – Perks in this strategy are a degree of protection is provided in case the security does not move or falls. Con in this strategy is lower profit potential in comparison with Long Call.
Rise to a Particular Level – Bull Market Scenario
In this outlook, the trader expects the price to rise to a particular point. Here are our recommended strategies for this particular kind of outlook:
Bull Butterfly Spread – Perk in this strategy is limited losses, in case the prediction of price movement is wrong. Con in this strategy are higher premium, as there are many transactions involved.
Bull Condor Spread – Perk in this strategy is high potential return. Con in this strategy is high premium payment, because of high number of transactions.
Moderate Fall in Share Price – Options Strategy in Bear Market Scenario
In this outlook, the trader expects the price to fall, but expect the margin to be tiny. We believe the following Options strategies would work best for this outlook:
Bear Put Spread – Perk in this strategy is fewer upfront cost, in comparison with buying puts. Con in this strategy is limited profit potential in case price falls significantly.
Bear Call Spread – Perk in this strategy is the possibility of creating profit on stable price. Con in this strategy is limited profit making possibility in case the price falls significantly.
Short Call – Perk in this strategy is possibility of profit with stable price. Con in this strategy is an unlimited loss, if the price hikes significantly.
Significant Fall in Share Price – Options Strategy for Bear Market Scenario
In this outlook, the trader expects the price to fall by a significant level. Check out the recommended strategies for this outlook:
Long Put – Perks in this strategy are fewer transaction followed by fewer commission. Con in this strategy is lack of protection against rise of stable prices.
Short Bear Ratio Spread – Perk in this strategy is a degree of protection against opposite price movement. Con in this strategy is profit making potential is lower than long put.
Fall to a particular level – Bear Market Scenario
In this outlook, the trader expects the price to fall, and expectation is of a fall to a specific level. It is believed, the following recommended strategies work best with such a condition:
Bear Butterfly Spread – Perk in this strategy is limited loss on account of odd price movement. Con in this strategy is high commission as there are multiple transactions included.
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Stable Price – Options Strategy in Neutral Market Scenario
In this outlook, the trader expects the price to remain unchanged for a particular time duration. For this particular situation, we would like to show you the best recommended Options Strategy:
Short Straddle – Perk in this strategy is upfront payment received. Con in this strategy is heavy loss incurred in case the price moves a lot.
Short Strangle – Perk in this strategy is profit making possibility even with a price movement. Con in this strategy is limited profit making possibility.
Butterfly Spread – Perk in this strategy is low upfront cost. Con in this strategy is high commission following multiple transactions.
Stable or tiny movement in north or south direction
In this outlook, the trader expects the price to stay stable and expect the price to move a little bit in either direction. Check out the strategies in connection with for this outlook:
Short Gut – Perk in this strategy is profit making possibility on account of stable price, small increase or small fall. Con in this strategy is a heavy loss can be incurred in prices move by a big margin.
Condor Spread – Perk in this strategy is limited loss. Con in this strategy is lowered profit making potential.
Albatross Spread – Perk in this strategy is a lot of profit making possibility from various outlooks. Con in this strategy is limited profit making potential.
Stable short term price followed by breakout in long term
In this outlook, the trader expects the price to stay stable for a short time, and then expect it to significantly rise or fall in future, on a long term basis.
Strategies you can deploy for such a situation or outlook are:
Calendar Strangle – Perk in this strategy is limited loss potential. Con in this strategy is multiple transactions involvement, which features higher commission.
Calendar Straddle – Perk in this strategy is the position is flexible, and can be adjusted according to changing outlook perception. Con in this strategy is high transactions involvement, which means higher premium.
Stable short term price followed by rise in long term
In this outlook, the trader expects the price to remain stable in short term but expects the price will rise in the future, i.e. a long term basis. See for yourself, the likely suitable strategies:
Calendar Call Spread – Perk in this strategy is limited loss potential. Con in this strategy is risk of call options being assigned.
Stable short term price followed by fall in long term
In this outlook, the trader expects the price to stay stable, and expects the price will fall in the near future, i.e. long term. Keep reading to discover the strategy which best suits this situation:
Calendar Put Spread – Perk in this strategy is limited potential of loss. Con in this strategy is put options being assigned in case price falls sooner.
Stable but a possible rise
In this outlook, the trader expects the price to remain stable, but may also expect the price to rise, and wants to take a call for both the outlooks.
Here is a quick guide on the strategy you can deploy for this particular outlook:
Covered Call – Perk in this strategy is profit earning potential from stable as well as rising prices. Con in this strategy is limited set of profit making possibility.
Stable but a possible fall
In this outlook, the trader expects the price to remain the same, but may also perceive the price will fall, and wishes to cover both the aspects.
The following mentioned strategy can be your best choice:
Covered Put – Perk in this strategy is profit making potential from stable prices and also fall in prices. Con in this strategy is fewer profit making potentials.
Significant movement in any direction – Options Strategy in Volatile Market Scenario
In this outlook, the trader expects the price to move significantly, but is not sure about the direction in which the price may move.
Read the pros and cons of Option strategies which are best for this outlook:
Long Straddle – Perk in this strategy is unlimited profit making potential. Con in this strategy is loss incurred if the prices do not move drastically.
Long Strangle – Perk in this strategy is cost to carry the strategy is less than Long Straddle. Con in this strategy is price movement margins must be higher than Long Straddle.
Long Gut – Perk in this strategy is loss incurred will be lower than Long Straddle and Long Strangle. Con in this strategy is high upfront cost, in comparison with Long Straddle and Long Strangle.
Short Butterfly Spread – Perk in this strategy is profit earning potential from small price movement as compared to Long Straddle or Strangle. Con in this strategy is profit making potential is minimized.
Significant movement in any direction but likely to rise
In this outlook, the trader expects the price is highly volatile, but thinks the price will most probably rise. Keep a closer check on the following strategies for such an outlook:
Strap Straddle – Perk in this strategy is with rise in prices, profit earning will be higher than Long Straddle. Con in this strategy is higher loss making potential as compared to Long Straddle.
Strap Strangle – Perk in this strategy is upfront cost is less than Strap Straddle. Con in this strategy is price movement margin must be higher as compared to Strap Straddle in order to make profits.
Call Ratio Backspread – Perk in this strategy is lack of upfront cost requirement. Con in this strategy is higher trading level requirement with broker.
Significant movement in any direction but likely to fall
In this outlook, the trader expects the price to be highly volatile, and expects it to fall most probably than rise. You will find the best suited strategies for this outlook, in the pointers below:
Strip Straddle – Perk in this strategy is higher profit earning potential in case security falls in price, as compared to Long Straddle. Con in this strategy is higher potential loss possibility as compared to Long Straddle.
Strip Strangle – Perk in this strategy is lower upfront cost than Strip Straddle. Con in this strategy is a higher price movement must take place, as compared to Strip Straddle.
Put Ratio Backspread – Perk in this strategy is lack of upfront cost requirement. Con in this strategy is higher trading level holding requirement, with broker.
Choosing the Right Options Strategy – Conclusion
We tried to provide all the information on right options strategy, which will set you on a path of making profits with appropriate risk management.
It is probably a necessity for traders to be well versed with all the strategy and also know how they must be put to use. This will perhaps make earning great returns a constant fashion.
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