Option Trading Strategies

Table of Contents
Chapter 1: Introduction to Options Trading
Chapter 2: Options Trading Terminology
Chapter 3: Option Trading Strategies
Chapter 4: Types of Options Trading
Chapter 5: Common Applications of Options Trading
Chapter 6: How to Trade Options

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Chapter 3: Option Strategies
Put Option
Hold a Call
Exercising the Option

Chapter 3: Option Strategies

Any investor who wants to trade in options must have a clear understanding of how options work. There is a theory in options trading that speculation must have its own rewards because there is a considerable risk involved. An option is a purely speculative instrument and its success depends on how well you gauge the market and how correctly you time your option trades.

Consider an option you hold on Apple shares. The strike price is $250 and the expiration date is August 30. Say, on August 1st, the share price moves up to $280.

Scenario 1: You hold a put option on these shares

Your position is giving you a loss as if you exercise the option, you will have to buy shares at $280 from the market. The situation could get worse if the price rises further. The good new is that your position is insulated against price rise as you do not have an obligation to sell the shares. You can let the option expire, though it will mean that you will lose the premium that you paid for the option.

Scenario 2: You hold a call option on these shares

If you have a call option on the same shares, which gives you the right to buy the shares at $250, then you are in a profit making position. You have two alternatives:

Closing out the position: If you feel that the price has already risen enough, you can close your position and cash out your gains. The higher the difference between your strike price and the market price of the share, the more the profit you will end up making.

Exercising the Option

If you think the company is likely to do well in future and you would like to own its shares, you can simply exercise your option. Doing this will allow you to buy shares at a price of $250 per share instead of the market value. You can sell them immediately to gain from the difference between your purchase price and the current market price or you can choose to hold on to the shares.

Before you start investing in options, you need to have a clear understanding of how you can use them to your advantage. The basic concept to remember is that the option freezes your sale or purchase price for a specified time period. Within this period, you can track the change in value of the option’s underlying asset to exercise the option, close your position, or to let the option expire.

Next Chapter: Types of Options Trading