You can learn options trading to increase leverage in your trades, and also use it to protect your long-term investments, and limit your risks in times of high market volatility.
We share our favourite options strategies for beginners to shorten their learning curve, become advanced options traders and use new trading tools to find new ways to profit.
Contents
- Use Covered Call to Reduce the Cost of Stock Purchase
- Use Cash Secured Put To Buy Stocks at a Discount
- Use Poor Man’s Covered Call to Reduce the Buying Power of Covered Call
- Buy Leaps Call to Increase Leverage on Bullish Trades
- Sell Put Credit Spread to Increase the Probability of Profit on Bullish Trades
- Sell Call Credit Spread to Profit in a Bearish Market
- Sell Straddle to Profit in a Neutral Trend
- Sell Strangle to Increase the Probability of Profit in Neutral Trade
- Trade Iron Condor to Reduce the Downside in a Neutral Trade
- Trade the Wheel Strategy to Increase Profits on Long-Term Investments
Use Covered Call to Reduce the Cost of Stock Purchase
Covered Call is an options trading strategy that hedges against a long stock position by selling OTM Call to collect a premium if the stock price doesn't rise.
When we combine buying 100 stocks with selling a Call option, we get a Covered Call strategy. The premium received from the short Call can reduce the cost of the stocks, and increase your chance of profit.
If the stock price increases past the Call strike before expiration, the 100 stocks will be sold at the strike price for a profit to compensate for the loss of the Call trade.
So a Covered Call caps the future upside of the stocks in exchange for the income from selling options.
If we want to hold onto a value stock for the long term, but are afraid of a bearish trend, we can trade the Covered Call to hedge our position.
Use Cash Secured Put To Buy Stocks at a Discount
Cash Secured Put is an options strategy that requires holding cash reserves of 100 stocks while selling a Put option.
Let's check out the profit analysis of selling an OTM Cash Secured Put option. We receive a premium when selling a Put. As long as the stock price does not drop below the strike price before expiration, the Put option value expires worthless, and the premium received becomes our profit.
The Put option will be exercised if the stock price drops below the strike price.
This means we are forced to purchase 100 stocks at the cost of the strike price less the premium received.
Cost per share = strike price - premium
Selling Cash Secured Put options is part of the Wheel Strategy, and a good long term strategy to buy-and-hold stocks.
In a bullish trend, we can continue to sell Cash Secured Puts for income through premiums. In a bearish trend, we would purchase the stocks at the strike price, which is lower than the original market price, then wait for the blue-chip stock to bounce back in the future.
Use Poor Man’s Covered Call to Reduce the Buying Power of Covered Call
Poor Man's Covered Call combines a long deep ITM long-term Call and a short OTM Call option.
A Poor Man's Covered Call on BABA uses only $3,825 in buying power, less than half of the Covered Call:
- A 0.90 delta long Call at $50 that expires 5 months later.
- A short 0.20 delta OTM Call at $110 that expires next month.
If the stock prices doesn't rise beyond $110 before expiration, we profit $231 from the short Call premium. If the stock price goes up beyond $110, the maximum profit from the Poor Man's Covered Call is $2,175.
However, if the stock price drops below $50 within 5 months, the value of the options becomes worthless.
The advantage of a Poor Man's Covered Call is to earn similar profits with less capital investment.
| Strategies | Buying power | Short Call premium (%) | Maximum profit (%) |
|---|---|---|---|
| Covered Call | $8,595 | $231 (2.7%) | $2,405 (28%) |
| Poor Man's Covered Call | $3,825 | $231 (6.0%) | $2,175 (57%) |
If the stock price shoots up, the Poor Man's Covered Call gives us a higher Return on Capital.
But if the stock price falls unexpectedly, the Covered Call trader can patiently wait for the stock to rebound in the future. On the other hand, the Poor Man's Covered Call trade needs to close before the options expire, giving us less time to respond when the market goes down.
Buy Leaps Call to Increase Leverage on Bullish Trades
LEAPS Call is a Call options contract with at least 1 year to expiration. A long LEAPS Call is a long-term bullish trade with a great return on capital.
If we believe the PayPal stock price has reached a bottom, and anticipate a bullish trend, we can buy a 0.90 delta LEAPS Call at $40 that expires in a year.
The trade requires $4,210 in buying power and will be profitable when the stock price rises beyond $82.1 in a year.
A long LEAPS Call has higher leverage than buying stocks, and will have a greater return on capital if the stock price rises as expected.
Sell Put Credit Spread to Increase the Probability of Profit on Bullish Trades
Bull Put Credit Spread works by combining a short Put and a long Put at different strike prices that expire at the same time. The Put Vertical Spread is profitable if the underlying price goes up before the option expires.
Compare this to a short Naked Put, a Bull Put Vertical Spread can limit the maximum loss if we are wrong about the direction.
If we are confident about a bullish outlook, trading a short Bull Put Spread has higher leverage than buying stocks.
Sell Call Credit Spread to Profit in a Bearish Market
Bear Call Credit Spread works by combining a short Call and a long Call at different strike prices that expire at the same time.
Compare this to a short naked Call, a Bear Call Spread can limit the maximum loss if we are wrong about the direction. The Return on Capital is also higher for a Bear Call Spread.
Sell Straddle to Profit in a Neutral Trend
Short Straddle options strategy works by selling an ATM Put and an ATM Call to receive a huge premium. As long as the underlying price does not move beyond the breakeven prices before expiration, the Straddle seller can buy to close the two options for profit.
If the underlying stock price doesn't move beyond the boundaries before expiration, the neutral Straddle strategy will be profitable.
Sell Strangle to Increase the Probability of Profit in Neutral Trade
Short Strangle options strategy works by selling a Put and a Call to define a range you can profit from. As long as the underlying price does not exceed or drop below the strike prices of Put and Call before expiration the two options contracts will depreciate and we profit as an options seller.
If the underlying stock price doesn't move beyond the boundaries, the short Strangle will be profitable.
Trade Iron Condor to Reduce the Downside in a Neutral Trade
Iron Condor works by selling a Put Spread and a Call Spread to define a range you can profit from. As long as the underlying price does not exceed or drop below the strike prices of Put and Call before expiration the four options contracts will depreciate in value and we profit as an option seller.
If the underlying stock price remains stable, the Iron Condor strategy will be profitable. The maximum loss is also capped if we are wrong.
Trade the Wheel Strategy to Increase Profits on Long-Term Investments
Wheel Strategy is a set of steps to combine trading options with stocks to increase the returns over the traditional buy-and-hold strategy.
The 3 steps of the options strategy depend on the number of shares you hold:
- Sell a Cash Secured Put when holding 0 shares
- Sell a Strangle (a Put and a Call) when holding 100 shares.
- Sell 2 Call options when holding 200 shares.
1. Sell a Cash Secured Put When Holding 0 Shares
When we do not own any SPY stock, we can sell a Cash Secured Put that expires in 30 days.
If SPY does not drop below the strike price after 30 days, we will collect all the premium from the trade.
If SPY price drops below the strike price, we will be assigned 100 shares of SPY at a discount. Then we move on to the next step.
2. Sell a Strangle When Holding 100 Shares
Now we own 100 shares, we can sell a Strangle that expires in 30 days, which is a combination of a Cash Secured Put and a Covered Call.
If the SPY price stays within the 2 strike prices after 30 days, we collect all the premium from selling options.
If the SPY rises beyond the Call strike, we will be forced to sell the 100 shares at a high price. Then we move back to step 1.
If the SPY price drops below the Put strike, we get to purchase another 100 shares at an even lower price. Then we move forward to step 3.
3. Sell 2 Covered Call Options When Holding 200 Shares
Now we own 200 shares of SPY ETF, we can sell 2 Covered Call options at the same time to earn twice the amount of premium.
If the ETF price doesn't rise after 30 days, we collect all the premium.
If the SPY price increases beyond the Call strike, we will sell 200 shares at a high price and move back to step 1.
Wheel Strategy is great for increasing the returns on investing in blue-chip stocks.
Now you know how most beginner options strategies work, you are ready to take advantage of our membership services to find high probability trades.
Thank you for the tips.
I finally have something other than covered calls to try.