This article will outline several conservative options strategies.
1. CASH SECURED PUTS
CSPs are used to collect premiums even before holding the underlying stock. CSPs are used to raise capital while waiting for the options to expire. Your margin requirement will depend on your strike price selection. Basically, shorter time period will provide much higher rate of return. Higher volatility will provide higher premiums. CSP will generate loss when the stock plunge below the strike price, thus CSP needs careful trade management from the traders.
2. COVERED CALL
Once you hold the stock, sell a call on it to reduce its cost basis. The call strike price selection will depend on your plan on the stock holding. If you plan to exit at the first chance, you may select ATM call. Selecting ITM call will give you higher downside protection, but your stock liquidation value will have loss. OTM call will give you potential upside when the stock price appreciate. Remember, the intention of covered call strategy is to get called and collected the premium in process.
Covered call requires minimal trade management, if the trader accepts the pre-calculated return before entering the trade.
3. BULL PUT spread (credit spread)
Bull put spread consists of 2 legs: one short put and one long put. The difference on strike price determine your net position: credit or debit. Basically, the short put need to finance the long put, so you get lower return but higher safety from market downside. Bull put spreads is a safer version of CSP. You collected premium will be lower due to your purchase of downside protection, but your trade will approach delta neutral trades and you’re still collecting premiums.
4. BEAR CALL spread (credit spread)
Bear call spread capture the market down move by selling calls during bearish market. The idea is that the short calls will be expired worthless as the market grinding down. If you can sell naked call, you can do it instead of setting bear call spread, but your risk will be unlimited on the upside. The bear call spread limit your risk buy hedging the upside potential using a long call on the spread. The short call should provide credit for the long call.
5. BULL CALL spread (debit spread)
This spread is the extended version of single leg long call trade. Long call is a bullish trade with limited loss potential and virtually unlimited profit potential. Bull call spread adds one leg into the trade with the purpose to reduce the long call cost basis by selling further OTM call. The spread has lower risk, but capped potential reward.
6. BEAR PUT spread (debit spread)
This spread is the extended version of single leg long put trade. Long put is a bearish trade with limited loss potential and virtually unlimited profit potential. Bear put spread adds one leg into the trade with the purpose to reduce the long put cost basis by selling further OTM put. The spread has lower risk, but capped potential reward.
Other complex strategies such as butterflies, flies, condors can be useful too. But in my opinion, adding too much legs on your trades can complicate your trade adjustments later. Not too mention, your rising transaction costs might bite into your trade results.
Iron Condor is very productive strategy to use during ranging market. Butterflies are used to lock profit and release buying power for other trades. I use both strategies for generating income using SPX index. Index options are European style and settled into cash after expiry.
The options trading sometimes dictates the trader to morph his trade into more profitable trades by doing trade adjustments. The two key purpose of trade adjustments are:
1. To reduce or limit risk
2. To realign existing trade
Basic trade adjustments usually morphs single leg trades into spreads.
Rolling short options for more credit and long options for less debit are very important strategy for options traders.
I will investigate later on the more complicated strategies as the situation dictates their usefulness in my trades.
Andreas Kodyat Blog 