Options Trading is a great means to engage in position trading and risk management. Creating the right options strategies will enable you to maximize your profits while minimizing the risk of incurring a loss. When starting out in the options market, you can choose from among several strategies - but before you do that, it is important to know your options correctly.
As an option holder, you can, but aren’t obliged, to sell or buy the underlying asset at a specific price before it expires. Fundamentally, there are two types of options: a call, which allows its holder to buy the option, and a put, which allows the holder to sell that option.
Call Option v/s Put Option
While the call option enables the buyer to buy the underlying asset, a put option gives its buyer the right to sell the asset.
Call Options
When you buy a call option, you can opt to buy the underlying asset at a previously specified price before the contract expires. Naturally, as a buyer, you would want the price of the asset to increase. On the other hand, the seller of the call option would expect the price of the asset to fall.
Some Popular Call Option Strategies
Long Call: You can buy a call option of an underlying asset that is already a part of your portfolio.
Bull Spread: You can sell in-the-money call options that will strike a higher price and, with the same capital, buy out-of-the-money call options on the same underlying asset and with the same expiry date.
Covered Call: You can sell in-the-money call options of an underlying asset in your portfolio.
Rewards and Risk: When buying call options, you can earn unlimited profit, while the loss is only restricted to the premium that has been paid. On the other hand, when selling call options, the maximum profit is equal to the premium, while the loss incurred can be unlimited.
Put Options
When you buy a put option, you can sell the underlying asset at strike price before the contract expires. As a buyer, you will expect the value of the security to fall, so that you can you can protect the downside risk, or better, profit from the downside.
Some Popular Put Option Strategies
Long Put: You can buy a put option of an underlying security (generally equity) that is already a part of your portfolio. It also acts as a hedging strategy.
Bear Spread: You can buy in-the-money put options that strike higher and sell an equal number of out-of-the-money put options on the same underlying asset having the same expiry month.
Rewards and Risk: When you buy a put option, the maximum loss that you can incur cannot be higher than the premium paid; maximum profit earned can be equal to the strike price, assuming the value of the underlying asset becomes zero. Inversely, when you sell a put option, the maximum profit is the premium paid and the maximum loss can go up to the underlying asset’s strike price.