option trading strategies for beginners

option trading strategies for beginners

A Guide Of Option Trading Strategies For Beginners

Options are conditional derivative contracts that allow buyers of the contracts a.k.a the option holders, to buy or sell a security at a chosen price. Option buyers are charged an amount called a "premium" by the sellers for such a right. Should market prices be unfavorable for option holders, they will let the option expire worthless and thus ensuring that the losses are not higher than the premium. In contrast, option sellers, a.k.a option writers assume greater risk than the option buyers, which is why they demand this premium.

Options are divided into "call" and "put" options. A call option is where the buyer of the contract purchases the right to buy the underlying asset in the future at a predetermined price, called exercise price or strike price. A put option is where the buyer acquires the right to sell the underlying asset in the future at the predetermined price.

Why trade options rather than a direct asset?

There are some advantages to trading options. The Chicago Board of Option Exchange (CBOE) is the largest such exchange in the world, offering options on a wide variety of single stocks and indices. Traders can construct option strategies ranging from simple ones usually with a single option, to very complex ones that involve multiple simultaneous option positions.

[Options allow for both simple and more complex trading strategies that can lead to some impressive returns. This article will give you a rundown of some basic strategies, but to learn practice in detail check out Investopedia Academy's Options Course, which will teach you the knowledge and skills the most successful options trader use when playing the odds.]

The following are basic option strategies for beginners.

This is the preferred position of traders who are:

  • Bullish on a particular stock or index and do not want to risk their capital in case of downside movement.
  • Wanting to take leveraged profit on bearish market.

Options are leveraged instruments – they allow traders to amplify the benefit by risking smaller amounts than would otherwise be required if the underlying asset traded itself. Standard options on a single stock is equivalent in size to 100 equity shares. By trading options, investors can take advantage of leveraging options. Suppose a trader wants to invest around $5000 in Apple (AAPL), trading around $127 per share. With this amount he/she can purchase 39 shares for $4953. Suppose then that the price of the stock increases about 10% to $140 over the next two months. Ignoring any brokerage, commission or transaction fees, the trader’s portfolio will rise to $5448, leaving the trader a net dollar return of $448 or about 10% on the capital invested.

Given the trader's available investment budget he/she can buy 9 options for $4,997.65. The a contract size is 100 Apple shares, so the trader is effectively making a deal of 900 Apple shares. As per the above scenario, if the price increases to $140 at expiration on 15 May 2015, the trader’s payoff from the option position will be as follows:

Net profit from the position will be 11,700 – 4,997.65= 6,795 or a 135% return on capital invested, a much larger return compared to trading the underlying asset directly.

Risk of the strategy: The trader's potential loss from a long call is limited to the premium paid. Potential profit is unlimited, meaning the payoff will increase as much as the underlying asset price increases.

This is the preferred position of traders who are:

  • Bearish on an underlying return but do not want to take the risk of adverse movement in a short sell strategy.
  • Wishing to take advantage of leveraged position.

If a trader is bearish on the market, he can short sell an asset like Microsoft (MSFT) for example. However, buying a put option on the shares can be an alternative strategy. A put option will allow the trader to benefit from the position if the price of the stock falls. If on the other hand the price does increase, the trader can then let the option expire worthless losing only the premium.

Risk of the strategy: Potential loss is limited to the premium paid for the option (cost of the option multiplied the contract size). Since payoff function of the long put is defined as max(exercise price - stock price - 0) the maximum profit from the position is capped, since the stock price cannot drop below zero (See the graph).

This is the preferred position of traders who:

  • Expect no change or a slight increase in the underlying price.
  • Want to limit upside potential in exchange of limited downside protection.

The covered call strategy involves a short position in a call option and a long position in the underlying asset. The long position ensures that the short call writer will deliver the underlying price should the long trader exercise the option. With an out of the money call option, a trader collects a small amount of premium, also allowing limited upside potential. Collected premium covers the potential downside losses to some extent. Overall, the strategy synthetically replicates the short put option, as illustrated in the graph below.

Suppose on 20 March 2015, a trader uses $39,000 to buy 1000 shares of BP (BP) at $39 per share and simultaneously writes a $45 call option at the cost of $0.35, expiring on 10 June. Net proceeds from this strategy is an outflow of $38.650 (0.35*1,000 – 39*1,000) and thus total investment expenditure is reduced by the premium of $350 collected from the short call option position. The strategy in this example implies that the trader does not expect the price to move above $45 or significantly below $39 over the next three months. Losses in the stock portfolio up to $350 (in case the price decreases to $38.65) will be offset by the premium received from the option position, thus, a limited downside protection will be provided.

Risk of the strategy: If the share price increases more than $45 at expiration, the short call option will be exercised and the trader will have to deliver the stock portfolio, losing it entirely. If the the share price drops significantly below $39 e.g. $30, the option will expire worthless, but the stock portfolio will also lose significant value significantly a small compensation equal to the premium amount.

This position would be preferred by traders who own the underlying asset and want downside protection.

The strategy involves a long position in the underlying asset and as well as a long put option position.

An alternative strategy would be selling the underlying asset, but the trader may not want to liquidate the portfolio. Perhaps because he/she expects high capital gain over the long term and therefore seeks protection on the short run.

If the underlying price increases at maturity, the option expires worthless and the trader loses the premium but still has the benefit of the increased underlying price which he is holding. On the other hand, if the underlying price decreases, the trader’s portfolio position loses value but this loss is largely covered up by the gain from the put option position that is exercised under the given circumstances. Hence, the protective put position can effectively be thought of as an insurance strategy. The trader can set exercise price below the current price to reduce premium payment at the expense of decreasing downside protection. This can be thought of as deductible insurance.

Suppose for example that an investor buys 1000 shares of Coca-Cola (KO) at a price of $40 and wants to protect the investment from adverse price movements over the next three months. The following put options are available:

3 Binary Options Trading Strategies For Beginners

Note! If you are new to binary options and different strategies please go to our strategy page where we cover the topic comprehensively!

If you’ve studied and understood my previous posts about the fundamentals of binary option FX trading and binary options indicators, you are now ready to trade for real. Here are 3 different strategies that I use, choose one based on your risk appetite. Good luck!

Conservative Long-term Strategy

This strategy is for those who are new to this game and want to build up their capital slow and steady. The point of this strategy is to minimize risk and wait for the perfect setup on the chart.

In this case the perfect setup is using the ZigZag’s last 2 points, and draw a Fibonacci between them in the direction of the trend.

Draw your fibo from point 1 to point 2 for a down trend, and vice versa for an uptrend. Your target is 161.8 projection level.

In order for the signal to be fully valid, there has to be a retracement to between 50 – 88.6. Higher the retracement goes, stronger the signal. In the example above, the retracement happens next to the number 2 in the up left corner.

They key here is to be patient until all 3 factors line up.

The entry rule is:

– Price hits Fibonacci projection level 161.8.

– Price is inside or outside of the bounds of the red channel.

– Value Chart hits level 8 or above

Your Expiry can be between 5 and 20 minutes. And your target is 1-2 trades per day.

And money management suggestion for this strategy is to take 2 equal bids per day for 20 days. Increase your position by 50% next day. If you lose, start with the last set of bids:

Day 3: 21 + 21… and so on. You should reach around 5k in profits within 20 days, and next month just start over or carry on from where you left.

Top Brokers for Beginners

The semi conservative strategy involves 4-6 trades per day. The rules are the same as for the conservative strategy, only with one exception: We take the trade at Fibonacci projection level 127 as well as 161.8.

Now, for level 127 trades, I would advise not to take the trade with more than 6 minutes to the expiry. This is because usually level 127 represents a consolidation level to draw buyers/sellers into the trend to get more liquidity and the price usually carries on in the direction of the trend within the next 3 candles.

The rules for entry are the same as with the conservative strategy:

– Value Chart hits level 8

– Price is inside the red zone

– Price hits the Fibonacci 127 projection level

Use the same money management as with conservative strategy, but your earnings will increase faster.

And remember, You have to stick with the entry rules.

Now, the below strategy is a very aggressive one that defines the means of sane trading. This strategy represents the use of price cycles and Fibonacci sequence in fast trading. Trades are not only taken at levels 127 and 161.8, but also at breakouts. And Fibonacci levels are drawn for every cycle. This strategy also exploit the full potential of value charts.

Above you learnt what you are hunting, where to find your prey, and how to bag some prey steady and safe. Now, we will go after the BIG 5.

Look at the chart below, how many price cycles do you see?

Yes, 9 cycles. Now, change your zigzag indicator parameters to 2,1,1. How many short-term price cycles do you see now?

Yup, 41+ short-term price cycles. In reality there are many many more, but let’s not make it too difficult. Each of these cycles is a Fibonacci sequence with a high-low-retracement-projection-reverse. Look at the chart below:

Now it gets complicated and wonderful:

  1. The Fibonacci is drawn between points 1 and 2 (in light blue)and marked on value charts the last high and low, 1 and 2 respectively. Now we have the levels and wait for the retracement which can be a wick, or a full candle. Above the retracement area is the white box marked by 3, and the green candle underneath touches that box.
  2. The setup is ready when the retracement candle is followed by a red candle in the direction of the trend. Now wake up.
  3. The next red candle closes below the open of the green retracement candle, BUT it doesn’t touch value chart level 6 yet, nor the regression channels inner band. This is marked by the light blue rectangle. So this is our first breakout candle of this specific sequence. We enter PUT 10 seconds before the close of this candle, as the next candle WILL BE BEARISH, with 90% probability. This is marked by 3 PUT on the chart above.
  4. The next candle closes below our 100 Fibonacci level but DOES NOT TOUCH LEVEL 127, which means it closed below the low of our current sequence. We enter PUT 10 seconds before the close of this candle because it will be followed by a bearish candle, or 2-3 bearish candles which will reach level Fibonacci level 161.8. This trade is represented on the chart by 1 PUT.
  5. The last bearish candle hits Fibonacci level 161.8 and value chart level -8 and also the outline of the red zone, so we place a CALL.

Within each price cycle between 3 points there are on average 3 ITM trade setups during normal volatility trading conditions. And for this strategy it goes without saying that if you don’t ‘feel’ the trade or something about the setup doesn’t seem right, don’t take it and wait for the next one.

This strategy will produce around 100 setups per currency pair per day, so use it wisely, and be very sure to learn it by heart before you jump in full steam.

The 3 strategies explained here work for all currency pairs, commodities, stocks and indices. However, even with the conservative strategy, a trader can produce excellent results if they trade 5-6 assets, and take 2 high probability trades per asset per day.

As usual leave comment below if you have any questions. Happy Trading!

Option Trading Strategies For Beginners and Veterans

Welcome to Option Trading Strategies Main Index Page

Option trading strategies are about the way we construct an option position, or combination of positions, in order to minimize risk and maximise profit while at the same time, taking advantage of our current view of the underlying financial instrument. Whether we anticipate the future price action of the stock, commodity future, index or currency pair to be directional or range trading will influence the way we use options to take advantage of this and profit.

On the other hand, we may have reasons to believe that a large move in the underlying is imminent but aren’t sure which way it will go. This may be due to price patterns we observe on charts or impending news releases. There are some option strategies which are ideal for this scenario too. Some are well known while others, hardly anyone knows about.

Options have several advantages over other leveraged instruments such as CFDs or futures. While futures may provide unlimited profits if the underlying goes in the anticipated direction, your losses can also be unlimited if it doesn’t. With options on the other hand, your losses are always limited to the amount of your investment, unless you have ‘shorted’ or sold options without any covering long position. Most brokers won’t allow you to do this anyway, unless you have a large amount of capital to cover the potential consequences.

The other advantage with options is that you can construct a combination of long and short positions with different strike prices and either the same or different expiry dates. These extra dimensions of ‘strike prices’, option expiry dates, together with the ability to sell or ‘write’ option contracts as well as buy them, is the very thing that creates the opportunity for a number of option trading strategies.

So let’s take a look at what’s on offer. Some of these you may be familiar with because they are well known and taught by popular courses; others are well kept secrets used by professional traders.

Types of Option Trading Strategies

The long iron butterfly is another range trading strategy and a variation of the Iron Condor. Both these strategies use two credit spreads one using calls, the other puts.

Calendar Spreads are a popular low risk, high profit potential, options strategy for traders who believe that an underlying security, is going to be trading within a range in the near term.

Butterfly Spreads are one of the most well known and popular option strategies out there today. Combining a debit and credit spread, they have huge profit potential, sometimes 300 percent.

The Long Condor Spread is a setup that is attractive because, although you pay a bit more in brokerage, the risk to reward potential can be quite outstanding.

The Iron Condor Spread is really just two credit spreads combined, but facing opposite directions separated by a range in between. But it this gives it distinct advantages over credit spreads alone.

In this iron condor option strategy we show you the best way to leg into positions safely and also to adjust your positions when they are threatened.

The short straddle strategy is normally considered to be a risky option trade due to potentially unlimited risk. However, if you use it with trading the underlying profits are almost certain.

The great thing about an options straddle is that you don’t have to pick market direction. But success comes with knowing the right signals to look for.

I’d like to share with you a straddle option strategy which I think works very well and at the same time, lowers your overall risk in each trade.

The Option Strangle relies on three assumptions: (1) No opinion as to the short term future direction of the underlying (2) That price action will become volatile (3) that the options are cheap.

The short iron butterfly strategy is pretty much the exact reverse of the Long Iron Butterfly. It is best suited to the kind of price action you believe a price breakout is imminent.

Once you understand how delta neutral trading really works, you can use it to adjust unprofitable positions to make them profitable again.

This little known strategy risks only a few dollars to potentially make hundreds or even thousands. Amazing!

Options arbitrage strategies take advantage of disparities that occur between put and call option prices. When this happens, risk free trading opportunities present themselves.

Before you trade option debit spreads, your policy should be to pay not more than 50 percent of the difference between strike prices. You get a distinct advantage over simple long option positions.

With credit spreads you can use option ‘time decay’ to your advantage and give yourself an 80 percent trading edge! You also have the flexibility to adjust your postions if it doesn’t work out. Here’s how …

The beauty of the ratio calendar spread is that you make some profit if the underlying goes nowhere, more profit if it moves as you anticipate and maybe even some if it goes slightly against you.

Ratio backspreads are considered to be one of the safest longer term option trading strategies available today – so much so, that they have sometimes been called “vacation spreads”.

In this ratio spread example we discuss a variation of the concept to demonstrate how these trade setups can not only be safe, but given the right conditions, provide a huge return on investment.

The call ratio backspread is a bullish options strategy. The appealing thing about this strategy, is that it involves limited downside risk when compared to just buying calls.

Bearish options strategies are for those traders who believe the price action of the underlying asset will move downwards. We explore a number of strategies here.

Bullish options strategies are for those traders who believe the price action of the underlying asset will move upwards. Long calls, bull call spreads, bull put spreads and other strategies are used.

5. Other Option Trading Strategies

Since binary options always have an absolute outcome (you either win or lose) then one of the most important factors in any good binary options strategy should be your money management program.

Dow Jones 30 stocks option trading is about trading options on each of the individual stocks that make up the famous Dow Jones Industrial Average, not about trading the DJI index itself.

Did you know that if you’re thinking of owning shares, you could be using options to buy stocks so much cheaper than if you just went to your broker and simply bought them at market price?

Is it possible to engage in risk free option trading and get away with it. The answer is ‘yes’! Here’s how …

Ratio trading is a relatively new options trading technique, used only by about the top one percent of all traders in the world. It needs to be distinguished from ratio spread trading.

Trading short term binary options can be quite an exciting way to make a living. Here we demonstrate trading strategies to successfully trade the 60 second and 5 minute time frames.

Option trading strategies for beginners

You decided to try trading. Whichever instrument you choose – CFDs or Binary Options, having a unique approach to analysis of financial markets is That is why binary options trading strategies are your main weapon. There is a big set of such strategies, if you want to succeed, you must actively learn and apply the ones that you like and seem promising. Begin training with simple trading strategies for newbies. It should be recalled that binary options and CFDs are a bit of a part of the vast and complicated mechanism – the financial market, which is not so chaotic and random as it may seem, but this market operates with certain patterns that can be used to make better predictions in CFDs and binary trading.

The result of the option is directly dependent on the general situation in the market and the specific current price for a particular asset. Only by applying certain trading strategy, trader can trade successfully and as a result, earn on his investments.

Remember that any strategy, even seemingly win-win, does not work ideally all the time. The loss is possible and you can lose money, but, more importantly, do not lose all at once. Allowing the possibility of episodic subsidence of capital, you should not put all the money into one trade or underlying asset. It is very risky and reckless. Ideally, you should have the funds, at least for ten investment. Such a reasonable and prudent attitude towards deposit called funds diversification. Let the idea of diversification has never leaves your mind.

This strategy is uncomplicated, would say even an elementary simple, and it is ideal for beginners who have no experience, no serious capital on deposit. It does not guarantee one hundred percent of success, but its probability, according to conservative estimates, is close to eighty percent. During the day, you can use it repeatedly, increasing thus your small capital unless, of course, you are quite reasonable, and good luck will not turn away from you.

Five Minutes strategy is based on the fact that many brokers allow you to buy options on their extreme extent – in five minutes before the expiration. All you need is to rummage around the assets in the market and find one that is stable and growing for a long time or, conversely, decreases. Do not forget to trace its maximum value, which, for sure, this time may be a turning point for the trend, and reached a historic high, trend likely will change the motion vector to the opposite.

Appropriate Trend for 5 Minutes Strategy

The principle of the Martingale is considered to be less risky when trading binary options. Martingale principle is based on doubling the following amounts, if the previous trade failed. That is, if you lose $100, you have to trade again with an amount of $200. If you lose $200, it is the time just to put $400. You should double your trading amount as long as you win, otherwise all the previous trades to turn very significant loss.

Learn more about martingale strategy in following article

Therefore, to apply the principle of Martingale in its purest form, relying solely on luck, is very risky. You should find the currency pair, with a clear up or down trend of price movement. It is logical to assume that this trend will not change in the near future. You should use this temporary stability. It is more reliable to trade binary options by Martingale principle using binary option indicators. Binary options signals already give you a chance to win, and using the principle of Martingale you will greatly increase it.

You should track an asset on 15 minutes timeframe, if we see three or more consecutive candles of the same color, let’s wait for a rollback. We should buy binary option after 2 minutes hoping for rolling back. For example, we see that three white candles closed, new candle opens and it goes in the opposite direction – the price decreases. We wait two minutes to make and fix it rolled back and buy Put binary options with a term of expiration at the close of the current candle i.e. after 13 minutes. Buying an option is still recommended in the case when the bodies of three candles together make up more than 15 points.

Example of Pattern Needed

Triangles are different, but they all show the imminent breakthrough price. Some of them – are rising, portend the imminent increase in prices and a break up, but falling triangles, on the contrary, are harbingers of its likely fall. Accordingly, traders have to trade on an increase or decrease of the price when you see that the chart has formed the corresponding figure.

In an uptrend, price movement forms the ascending triangle. To see it, trade should visually draw two lines through the points of resistance and support. Resistance line (higher) must be horizontal and support line is located at an angle thereto. It is obvious that in a downtrend, traders have to look for a downward triangle. In descending triangle, support line is horizontal, resistance line disposed at an acute angle to it – on sinking maximum points.

6 Great Option Strategies For Beginners

Option rookies are often eager to begin trading – too eager. It’s important to get a solid foundation to be certain you understand how options work and how they can help you achieve your goals – before trading.

Here’s a list of my favorite methods. Note: this list contains strategies that are easy to learn and understand. Each is less risky than owning stock. Most involve limited risk. For investors not familiar with options lingo read our beginners options terms and intermediate options terms posts.

1. Covered call writing. Using stock you already own (or buy new shares), you sell someone else a call option that grants the buyer the right to buy your stock at a specified price. That limits profit potential. You collect a cash premium that is yours to keep, no matter what else happens. That cash reduces your cost. Thus, if the stock declines in price, you may incur a loss, but you are better off than if you simply owned the shares.

Example: Buy 100 shares of IBM

Sell one IBM Jan 110 call

2. Cash-secured naked put writing. Sell a put option on a stock you want to own, choosing a strike price that represents the price you are willing to pay for stock. You collect a cash premium in return for accepting an obligation to buy stock by paying the strike price. You may not buy the stock, but if you don’t, you keep the premium as a consolation prize. If you maintain enough cash in your brokerage account to buy the shares (if the put owner exercises the put), then you are considered to be ‘cash-secured.’

Example: Sell one AMZN Jul 50 put; maintain $5,000 in account

3. Collar. A collar is a covered call position, with the addition of a put. The put acts as an insurance policy and limit losses to a minimal (but adjustable) amount. Profits are also limited, but conservative investors find that it’s a good trade-off to limit profits in return for limited losses.

Example: Buy 100 shares of IBM

Sell one IBM Jan 110 call

Buy one IBM Jan 95 put

4. Credit spread. The purchase of one call option, and the sale of another. Or the purchase of one put option, and the sale of another. Both options have the same expiration. It’s called a credit spread because the investor collects cash for the trade. Thus, the higher priced option is sold, and a less expensive, further out of the money option is bought. This strategy has a market bias (call spread is bearish and put spread is bullish) with limited profits and limited losses.

Example: Buy 5 JNJ Jul 60 calls

Sell 5 JNJ Jul 55 calls

or Buy 5 SPY Apr 78 puts

Sell 5 SPY Apr 80 puts

5. Iron condor. A position that consists of one call credit spread and one put credit spread. Again, gains and losses are limited.

Example: Buy 2 SPX May 880 calls

Sell 2 SPX May 860 calls

and Buy 2 SPX May 740 puts

Sell 2 SPX May 760 puts

6. Diagonal (or double diagonal) spread. These are spreads in which the options have different strike prices and different expiration dates.

1. The option bought expires later than the option sold

2. The option bought is further out of the money than the option sold

Example: Buy 7 XOM Nov 80 calls

Sell 7 XOM Oct 75 calls This is a diagonal spread

Or Buy 7 XOM Nov 60 puts

Sell 7 XOM Oct 65 puts This is a diagonal spread

If you own both positions at the same time, it’s a double diagonal spread

Note that buying calls and/or puts is NOT on this list, despite the fact that the majority of rookies begin their option trading careers by adopting that strategy. True, it’s fun to buy an option and treat it as a mini-lottery ticket. But, that’s gambling. The likelihood of consistently making money when buying options is small, and I cannot recommend that strategy.

Mark Wolfinger is a 20 year CBOE options veteran and is the writer for the blog Options for Rookies Premium. He also is the author of the book, The Rookie’s Guide to Options.

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