Trading options is a popular way for investors to make money in the market. While basic option strategies allow for big swings and big risks, more advanced multi-leg options strategies offer traders the ability to hedge their risks, providing them with more precise exposure and potential payoffs.
However, all options strategies are based on the two fundamental types of options: calls and puts. Below, we will explore five advanced strategies, their risks, rewards, and when traders might consider using them. These multi-leg strategies are more intricate than the basics, exposing traders to more detailed risks, but they are not without risk. It is important for traders to have a good understanding of call options and put options before delving into these more complex strategies.
1. Bull call spread
The bull call spread strategy involves buying a call at a low strike price and selling a call at a high strike price with the same expiration. This strategy is used when the trader expects the stock to rise towards or exceed the high strike price by expiration. The profit on this trade is capped at the difference between the two strike prices. By implementing this hedged trade, traders can reduce their break-even point and potentially multiply their profits faster compared to a long call position alone.
Example: If Stock X is trading at $20 per share, a call with a strike price of $20 is trading at $1, and a call with a strike price of $24 is trading at $0.50, the cost of setting up this trade would be $50 per contract. This includes the $100 cost for the long call (1 contract * $1 * 100 shares per contract) minus the $50 premium received for the short call (1 contract * $0.50 * 100 shares per contract).
Below are the profit outcomes on the bull call spread at expiration for various stock prices:
Reward/risk: In this scenario, the trade breaks even at $20.50 per share, which is the strike price of the long call plus the net cost of the bull call spread. The potential upside on a bull call spread is limited to the difference between the two strike prices minus the cost of the strategy.
When considering when to use a bull call spread, this strategy is effective when anticipating a moderate rise in the stock price. It allows traders to reduce their break-even point and enhance their potential gains between the two strike prices.
2. Bear put spread
The bear put spread strategy is the opposite of the bull call spread, as it is designed to profit from a decline in the underlying stock. In this strategy, the trader buys a put at a high strike price and sells a put at a low strike price with the same expiration. The profit on this trade is limited to the difference between the two strike prices. Similar to the bull call spread, the bear put spread helps reduce the break-even point and potentially amplify profits compared to a long put position alone.
Example: If Stock X is trading at $20 per share, a put with a strike price of $20 is trading at $1, and a put with a strike price of $16 is trading at $0.50, setting up this trade would cost $50 per contract. This includes the $100 cost for the long put (1 contract * $1 * 100 shares per contract) minus the $50 premium received for the short put (1 contract * $0.50 * 100 shares per contract).
Below are the profit outcomes on the bear put spread at expiration for various stock prices:
Reward/risk: The trade breaks even at $19.50 per share in this example, with the potential upside limited to the difference between the two strike prices. The bear put spread is effective when expecting a moderate decline in the stock price, allowing for a reduced break-even point and accelerated gains between the two strike prices.
These are just two examples of advanced options strategies that traders can utilize to enhance their trading activities. It’s important to thoroughly understand the risks and rewards associated with each strategy before implementing them in a trading portfolio.
Ready to get started with options trading?
Before diving into options trading, it’s crucial to have a solid grasp of how options work and a comprehensive understanding of basic options strategies. Additionally, you’ll need to find a brokerage platform that supports options trading and apply for the necessary permissions. Each brokerage may have specific requirements for options trading, so be sure to review their criteria before proceeding.
Whether you’re considering riskier trades or safer income-producing strategies, it’s essential to weigh the potential risks and rewards of each options trade. By conducting thorough research and understanding the intricacies of options trading, you can make informed decisions and potentially maximize your trading success.
Editorial Disclaimer: All investors are advised to conduct their own independent research into investment strategies before making an investment decision. Past performance is not indicative of future results.