Option Investment Strategies

Option Investment Strategies

Background

Option trading is a relatively new investment opportunity for investors. Prior to the implementation of exchange-traded options, most investors were limited to only a few investment strategies: buy stock when the market was expected to increase, and short/sell stock when the market was expected to decrease.

As exchange traded options were introduced new investment strategies became available to the majority of investors which allow investors to profit in an up, down, or sideways market place. As a result, option trading has grown steadily and now the average investor can employ a broad range of investment strategies from conservative investment strategies to high risk investment strategies. This allows the average Joe to construct an investment strategy that will either increase expected returns while keeping the same risk levels or decrease risk levels while keeping the same expected returns.

Common Option Strategies

Before presenting the most common option strategies implemented, definitions of some key option terms, a description of option language and the most common market forecasts are necessary:

Key Option Terms:

1) Strike Price: the price the option must reach to be exercised.

2) Expiration month: the month the option expires in (expiration occurs on the 3rd Friday of the month)

3) Call: an option to buy stock in the future.

4) Put: an option to sell stock in the future.

5) Premium: value you pay for the option.

6) Exercise: implementing your right to buy (for a call option) or sell (for a put option)

7) American Option: Options that can be exercised at any point up to expiration.

8) European Option: Options that can be exercised only at expiration.

9) In The Money: the stock is trading at a point where the option can be exercised.

10) Out Of The Money: the stock is trading outside of the range where the option can be exercised.

Option Language Examples:

1) Buy the XYZ July 50 Call at $3.00
2) Sell the XYZ July 50 Call at $2.00
3) Buy the ZYX September 20 Put at $5.25
4) Sell the ZYX September 20 Put at $0.50

Here, you issue your order to buy/sell, (XYZ/ZYX) which is the stock ticker symbol, select the expiration month, select the strike price, select the type of option (Call/Put), and finally select the option premium which you bid when buying and offer when selling.

You will have one of the following stock market outlooks/forecasts:

1) Bullish: you believe that a stocks price will increase
a. An “Outright Bull”: you feel the price of a stock has the potential to increase substantially
b. A “Moderate Bull”: you feel there is limited opportunity for a stocks price appreciation.

2) Bearish: you believe that a stocks price will decrease
a. An “Outright Bear”: you feel the price of a stock has the potential to decrease substantially
b. A “Moderate Bear”: you feel there is limited opportunity for a stock decline.

3) Neutral: you believe the price of a stock will remain within a certain range.

Once you digest all these terms your ready to explore the three most common types of Option Strategies: Bullish Option Strategies, Bearish Option Strategies, and Neutral Market Strategies.