Options are financial contracts that give the buyer the right, but not the obligation, to buy or sell an underlying asset at a specific price, known as the strike price, on or before a specific date.
Understanding options involves knowing the key terms associated with these contracts.
– Strike Price: This is the agreed-upon price at which the buyer of the option can buy or sell the underlying asset.
– Value Time: The time value of an option is the premium paid by the buyer to the seller for the option to buy or sell the underlying asset. This premium reflects the amount of time remaining until the option expires.
– Volatility: The volatility of the underlying asset is a measure of the potential price movements of the asset. This volatility affects the price of options.
– Premiums: The buyer of an option pays a premium to the seller for the right to exercise the option. This premium is the price of the option.
There are several popular option strategies that traders use to manage risk and generate income. Each strategy has its own advantages and risks.
– Iron Condor: This strategy involves selling a call spread and a put spread on the same underlying asset. The trader profits if the price of the underlying asset stays within a certain range. However, if the price moves outside of this range, the trader can experience losses.
– Credit Spread: This strategy involves selling a call or put option at a higher strike price and buying a call or put option at a lower strike price. The trader receives a credit for this trade, which can be used to offset potential losses. However, if the price of the underlying asset moves against the trader, losses can occur.
– Selling naked Call and Put Options: This type of option strategy involves selling options that give the buyer the right to buy (call) or sell (put) the underlying asset at a specific price. The trader profits from the premiums received for selling the options. However, if the underlying asset price moves against the trader, losses can occur.
– Strangle: This strategy involves buying both a call and put option on the same underlying asset, with different strike prices. The goal is to profit from significant price movements in either direction. However, if the asset price doesn’t move substantially, the trader can experience losses.
Options strategies can be used in a long term investment plan
It can be used to generate income in the form of options premiums
You can use it if you think the stock price is going to drop, but you still want to maintain your stock position,
or if you think the stock will go up but below the strike of the CALL contract
1- Own stock (100 shares for a total security)
2- Sell CALL contract (1 contract = 100 shares)
You can sell naked put if you think the stock price is going to go up or stay above the strike,
use this on stocks you want to buy anyway, maybe you ll have these for less in case the price drop at the strike or below
You have to take into account that the risk in this strategy is if the stock drop to zéro, you can lose (X contract x 100 x the strike)
Watch the VIX (Volatility Index) to know when sell CALL/PUT
For better return, sell it when volatility is high > 20 %
You have to also watch the implied volatility of the options