Four Foundations of Stock Option Trading
In today’s markets, it is almost impossible to find any investment that offers more flexibility, leverage, and limited risk than stock option trading. Especially at this time in history with online option trading which puts the power of these sophisticated investments at the disposal of both the aspiring trader as well as the veteran trader? Unfortunately, the strengths of these investments are also the biggest obstacles to mastery for most traders as some strategies become seemingly to complex to master by most would-be option traders. However, by understanding the four basic stock option trading strategies you can construct a foundation for trading mastery with stock options. The four basic strategies you must understand are the long call, the short call, the long put, and the short put.
A long call strategy is taken when a trader is bullish on a given stock and looks to utilize the leverage of options to capture a greater gain on a stocks upward move. A call option allows the option trader to control 100 shares of a stock for a small premium while restricting his risk to just the price of the premium. This strategy allows your reward potential to be unlimited while your risk is limited to the cost of the call option. As the expiration date for the call option approaches though time decay works against this position so you must factor time into your trading decision when using this strategy.
The short call is easy to execute but is a risky strategy given the risk to reward profile which makes this somewhat of an advanced stock option strategy. The strategy is used if you believe that a stock is going to decline or stay at the present value. You implement the strategy by allowing someone to sell a call option to you. Your reward is the value of the premium at the time the call option is sold to you. This lets the seller of the option assign his risk to you while hedging his position. Time decay works for you as you approach the expiration date for the option you stand to gain more of the premium at assignment. The short call exposes you to uncapped risk if the stock rockets higher in price value and most brokers will not allow you to trade this strategy unless you are very experienced with stock option trading or hold a position in the stock that you are trading this strategy on.
The long put strategy is the inverse of the long call strategy where you are looking for the stock to decline rather than rally. When you buy a put option you control 100 shares of stock in a company and lets you take advantage of enormous leverage. Your reward potential is theoretically unlimited while your risk is limited to the cost of the put option. You must be sure to give yourself enough time to profit with your trading method because time decay works against you with this strategy.
The short put strategy is used if you are bullish on a stock or believe is will trade at the same price level. This is also similar to the short call and has the same implementation except you allow someone to sell you a put. You stand to gain short term income from the premium and time decay works for you as you approach the expiration date while the stock goes higher or stays at the same level. This is also considered an advanced strategy and you must be sure you have enough experience trading options before attempting to trade this strategy without a hedging position.
By gaining a deep understanding of these four stock option trading strategies you will have the foundation to having mastery of them for huge returns. You will not only gain mastery over them by trading them effectively as individual strategies but you will begin to understand how to combine them which will let you control your risk while putting yourself in the best possible position for big profits. There are over 70 option strategies to trade for superior returns in today’s markets and you learn how to use them all for your advantage but it all starts with these four basic strategies detailed here.