Options 101: Options Trading Cheat Sheet

Options 101: Options Trading Cheat Sheet
Options 101: Options Trading Cheat Sheet

Whether you are a seasoned investor or you are just beginning the up, down, and sometimes the sideway world of stock trading, your best friend and biggest ally is knowledge. The more you know about the way the stock market works, the more options you have to reach your goals. The more options you have you can begin taking advantage of certain strategies within those options.

That being said, there are options strategies in the stock market that might be confusing at first sight. With names like ‘Protective Collar’ and ‘Long Call Butterfly Spread’ you might be asking yourself if these are indeed options strategies or plays that a quarterback calls in the huddle of a football game!

They may have unusual names but all of the following options strategies are designed to limit risk and maximize return. Here’s the best at 10 options trading cheat sheet every investor should have at their disposal.

Here’s the options trading cheat sheet

1. The Covered Call Option

The Covered Call is a financial transaction where the investor selling call options owns the same amount of the underlying security. To initiate the transaction the investor owning the asset sells options on that asset to generate an income stream. A Covered Call is a great way to generate income in the form of options premiums.

If the investor holding the asset does not foresee any significant up or down in the near term they can generate income (premiums) for the account while they wait out the lull in the activity of the asset. The downside to a Covered Call is there can be no significant gains if the stock price unexpectedly rises above the strike price and the investor is required to keep 100 shares at the strike price per Covered Call initiated.

2. The Married Put Option

Also known as a Protective Put this strategy acts as an insurance policy to protect the investor from downside risks. To implement the Married Put the investor purchases the stock and immediately purchases Put Options for an equal number of shares on the original purchase. This strategy will establish a floor price in the event of a sudden sharp fall in the price.

The downside of this strategy is if the stock does not fall in price, the investor loses the premium paid for the Put Option.

3. The Bull Call Spread Option

The Bull Call Spread Option Strategy is used when the investor is bullish on the asset and is predicting/expecting a moderate increase in the price. The investor buys the stocks at a specific Strike Price and sells the same number of calls at a higher Strike Price. This will limit the amount of upside on the trade while reducing the net premium spent.

When an investor buys into a higher-priced stock this is used to offset the higher premium by selling higher strike calls against them.

4. The Bear Put Spread Option

In the Bear Put Spread Option, the same situation applies to the Bull Call Spread except when the investor sells the required number of shares they sell at a lower Strike Price.  In this scenario, the investor is predicting/expecting a moderate decrease in the stock price.

This particular option is highlighted by both limited losses and gains.

5. The Protective Collar Option

The Protective Collar Strategy is also called a hedge-wrapper or risk-reversal and it protects against large losses but also limits large gains. The investor buys an Out-of-The-Money (OTM) Put Option and at the same time writes an OTM Call Option.  Writing the call produces income and allows the investor to profit up to the Strike Price but not beyond should the price rise significantly.

This creates a neutral trade set-up that protects the investor in the event of falling stock.

6. The Long Straddle Option

When an investor wants to buy a stock that he or she is not sure about which direction the stock will go for the term, they will use the Long Straddle Option.

To do this the investor will purchase both Put and Call options on the same underlying asset with the same Strike Priceand expiration date. In theory, this option allows for unlimited gains with the maximum loss controlled by the cost of both contracts. The investor does not care which way the stock goes as long as it is a greater move than the sum total of the option.

7. The Long Strangle Option

The Long Strangle Option is similar to the Long Straddle except for the Put and Call options are purchased as OTM (Out-of-The-Money) options. The investor is only sure of one thing, the stock is going to jump big one way or another. This limits losses to the cost of the options because Strangle will always cost less than Straddle.

8. The Long Call Butterfly Spread Option

An investor will use a Long Call Butterfly Spread Option when they are unsure about the stock movement before the expiration date. The Butterfly is constructed by both bearish and bullish spread strategies and three different Strike Price points. Follow me here.

The Long Call Butterfly Spread consists of’

  • One in the money call option at a lower strike price
  • Selling two at the money call options
  • Buy one out of the money call option
  • A balanced ‘Butterfly Spread’ will have equal widths on a graph called ‘the fly’ which results in a net debit

You can definitely see a trend of complications the deeper into this list we go.

In Conclusion

Yes, the deeper the list the higher degree of complication! There are two options strategies left on the list, the Iron Condor and the Iron Butterfly that we leave you to explore at your leisure.

Just as mentioned at the beginning, if you stick to learning as much as you can whether it be options strategies or other components of investor treading, you can be successful. Just like a quarterback on a football team, you can lead your finances to the common goal of success!

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