Take a look at some of the time-tested strategies that new investors have used.
6 Option Trading Strategies for Beginners
If you have any sort of interest in investing in the market, you want to know what you are doing.
The biggest mistake that newcomers in investing make is when they don’t take the time to study the market, figure out how it works, and then make a plan that is related to and based upon all that they have learned.
The good news is that there are many strategies and methods created by others that you can rely on, even if you have never invested before. They all bear some similarities and some major differences too but each have their own value.
There is no wrong answer to your personal preferences for investing. Whether you prefer to take risks, or you like to exercise caution in your trading. Take a look at some of the time-tested strategies that new investors have used and decide which one looks and feels right for you.
The Top 6 Option Trading Strategies for Beginners
The truth is that you could spend a lot of time educating yourself on investing in any given market. In fact, some people stand the risk of learning too much and never actually setting their first investments.
There comes a point when you need to make the leap and purchase your first asset or stock.
When you find the strategy that’s right for you, you should follow it, see how it treats you on the market, and decide if you want to keep using it. The type of strategy that you use when investing depends on the type of buyer that you want to be.
That is perhaps the first thing you should ask yourself before you start your investing career: what type of investor do you wish to be. Do you want to be brave and adventurous or cautious and methodical?
Ask yourself these questions as you take a look at these top 6 strategies.
1. The Long Call
A long call is an option in which you or a buyer simply buys a call option or “goes long”. This is an easy to follow and common approach that assumes the stock in question will rise in value by a certain amount of time.
A long call is often used by bullish buyers who feel that the stock they are looking at has a chance to greatly rise in value before the call option’s expiration date, which is typically around six to nine months away from the buying period.
A long call like this is a great way for buyers to only experience the upside of a stock and its value. There is limited downside risk with most long calls and the holder’s portfolio is typically quite safe.
At the same time, the gains aren’t usually as big either but they are more consistent and reliable too. And if there is a sudden rise in the market across the board, there is a chance for a huge upside for buyers who have committed to a long call.
2. The Short Put
With a long call, buyers have faith that the value of their stock will rise during a given period. For those who follow through with a short put, they think similarly. They expect the price to rise above their strike price before the put expires.
The earnings here are the premium for selling their put when the strike price is reached. The maximum earnings are the premium on a short put.
If the price does reach that point, a buyer will purchase the stock in question. This means that someone who is doing a short put will only be purchasing an asset when a value is dropping and reaching a more suitable, comfortable, and inexpensive price point.
A short put is best for new traders who are looking to make a profit from the premiums that they pay on options. They might not make as much money on the actual value of a stock but they can make money on selling to another investor and turning a profit on the premiums that the new investors will be obligated to pay.
3. The Long Put
On the flip side of the short put is the long put.
A long put takes a look at a stock or asset, and the market price. They assume the price is going to fall below a speculated strike price before the expiration date. If the asset really does fall considerably, they have a huge margin for potential profit on the long side. But the prices do have to fall for that to happen.
While they won’t be at risk for excessive loss here, the seller could potentially lose their full premium on a long put. But they have more upside potential, because they aren’t limited to just earning the premium.
Using long puts is often paired with expectations for stocks to decline. Rather than shorting a stock, you can earn premiums on a long put. It is capped at your premium, but you could potentially have multiple premiums. And then if the stock never reaches your strike price, you are out your investment.
Making puts, whether long or short, are identical to making call options, with the exception that investors anticipate the asset's value to fall as opposed to rise when they are making a long put. Due to the much lower risk of a long put, people typically adopt this approach instead of short selling.
Investors who purchase puts only take a chance on the fee if the asset rises over the original strike price. Long puts may be a low-risk approach to benefit from declining prices based on the amount of the premium.
4. The Covered Call
Check out the covered call approach next.
For a covered call, an investor needs to first hold stock in the company. In order to get a premium, they have to then sell an option on said stock. However, the plus side to having the option and the stock is that you are more protected, with more limited risk for loss on the investment.
With any covered call, an investor is betting on a flat or perhaps declining stock price that doesn't drop too much and encourages the option buyer to allow their contract to lapse. The investor will thereafter be able to retain their premium payment.
The stock can rise consistently, or excessively, and you make back your premium. This could limit your income, but still protects income as well. On the downside, you could potentially lose your investment, apart from any premiums received. You want to be certain the stock is not going to fall significantly enough to cause you major loss.
If you own a stock and you want to generate a bit of income, a covered call might be a good option for you. You hold the stock, but also could make income on the premiums of the covered call.
5. Married Put
A married put is a little bit different from the other strategies. You may want to familiarize yourself with long puts to really grasp this strategy, but a beginner can make it work as well.
With a married put, the investor holds a long position and then purchases an “at the money” put option on the very same stock to protect against any sort of downfall or sliding in the price of the asset.
In a sense, you purchase a put, and your stock possession hedges the put just in case the prices fall instead of rise. Your hope is the prices will rise, but you’re protected if they don’t.
The married put is a combination of the stocks and options investment method. Investors can make these transactions concurrently, purchasing a put option for every 100 stock shares they acquire. A put is dependent on share values rising.
In a sense, you can potentially have unlimited upside through a married put, if the stock rises considerably. Your only cost is the cost of the put, since you own the stock. You can think of it as an insurance premium against declining prices.
Thanks to the hedged position, you are protected from any declining prices, and won’t take a huge stock loss because of it. Should the prices decline instead of rise, you will really only lose the cost of your put, and not anything else.
When you’re hoping or expecting stock prices to rise, that’s the perfect time to use a married put. And if the market moves the opposite of your expectations, you can remain protected, which is the best part of the deal.
6. Protective Put
The protective put has a similar concept to a married put, but it does work differently. The biggest difference between the two is when the stock is acquired for the put. In a married put, you can purchase the stock at the same time as your put.
However, in a protective put, you already have the stock in your portfolio, and you want to try to hedge it, or make some money on it. Much like the married put, your stock is a hedge against the downturns of the market.
It protects you from potential losses on the asset, but gives you the ability to take advantage of hopeful rises.
A protective put also reflects the long put, which is used when you hope prices are going to rise. Your long put strategy is simply protected by the ownership of the underlying stock. You can lose your premium, but you won’t take a total loss if prices decline, thanks to your ownership of the stock in question.
This is a great option for beginners that have stocks, or other assets, in their portfolio that they expect to rise considerably. It also hedges their potential losses, so it’s not as scary as just laying it all on the table unprotected.
Getting Started Trading Options
If you are new to investments at all, trading options can certainly be scary. They are described as risky, which often stems from a lack of understand about how they truly work. But if you can grasp the basics behind this approach, you will find that there are protected options, adventurous options, and calculated options.
As a beginner investor, you can choose the strategy that works for your risk perception. But how do you get started?
The first step is to have an investment account established that lets you trade options. You might already have this in place. If not, start considering your trading platforms, and choose what’s right for you.
From there, you should determine what strategy you are comfortable with, or look for the opportunity to jump in. Options are based off of trying to earn income, or trying to speculate what you expect a stock to do. If you have a portfolio, start by looking at your assets and seeing what you anticipate for those holdings.
Another way to get started is if you have an asset you’re watching or interested in. How, or what strike price, do you want to acquire the asset in question? Choose an option strategy, and then look for the opportunity to put it into action.
Choosing an Option Strategy
In option strategies, you can choose from either puts or calls. They have different advantages and disadvantages. They are also used for different approaches in most cases. Call options are generally used for the expectation of rising stock prices, while puts are used for expected declines.
You might have a specific stock in mind, or perhaps you just expect prices to fall or rise. So first, determine whether a put or a call is the right choice. Then, determine what stock might be advantageous for the put or call.
Stock Price Predictions
Once you decide whether a put or stock is the right choice, choosing a stock is the next step. In some cases, you might first choose a stock, and then determine whether a put or call is the best approach for that stock.
What do you think the market is going to do? Do you expect declines or inclines for this stock? Can you predict a target point to purchase or sell the stock? It’s a good idea to study the market, or work with someone who does.
The key here is to attempt to predict market movement, and then to execute accordingly with options.
Expiration Date Determination
We all know the stock market has a mind of its own. While you might have expectations or predictions on the market, these things sometimes take time to come to fruition. This is why options have expiration dates. It gives you a window of time for your predictions to take place.
There are both short-term and long-term expiration windows to choose from, so it’s up to you to pick the most fitting window. Many investors will go with longer windows, as it gives them more time to make a profit, or hit the strike price they are after.
Choosing longer timeframes for expiration can sometimes offer more protection from loss, and lower risks. It’s up to you to determine what window you are most comfortable with.
Advantages and Disadvantages of Options Trading
As with any type of investment approach, there are both advantages and disadvantages to be aware of. There are risks involved, even with hedged options. When you educate yourself on the pros and cons, you are more prepared.
Learning how these investment strategies work is the key so be sure to continue to do research and learn the ins and outs of options trading.
With the risks come the potential for profit and income. Start out small and simple with these beginner strategies. As you better understand the concepts, you can dive in deeper or use more complicated approaches.
These are the best advantages of options trading to be familiar with.
✔️ You could earn income
✔️ There is potential for high yields
✔️ You will be closely involved in observing the market for changes
✔️ You have the right, but not the obligation, to buy in some cases.
✔️ There are many different strategies available to use
✔️ Some options strategies are hedged and limit your risks
And these are some of the known disadvantages to options trading.
❌ In some cases, there are high potentials for loss
❌ These can be high risk investments in some cases
❌ You might lose more than you put in
❌ Many options gains are categories as short-term gains
❌ More challenging and complicated to understand.
Additional Options Strategies to Consider
We’ve shared the top strategies for beginners, but there are some additional strategies that might appeal to you as well. We do recommend that you try some basic strategies to have the best understanding of trading with options before you step into these intermediate choices.
- Vertical Spreads buy and sell options that are the exact same type at the same time. So, you would have a spread of either puts or calls, but they would have varying strike prices. Your expiration dates should be the same. This allows you coverage regardless of which direction the market moves.
- Long Strangles are very similar to straddles, but will ultimately be betting on going long. You go long for a put and call simultaneously, using the same expiration and different strike prices. You may be profitable if the stock moves lower or higher, depending on the strike prices.
- Long Straddles are often used in a volatile market, but doesn’t require you to predict up or down for your speculations. You will profit whether it goes up or down, because you get a call and a put to cover. Your options have the same strike price and expiration.
Put Your Options Strategies to Work
The best way to really get started on options strategies as a beginner is to simply choose a strategy and jump in. Start with something simple, or perhaps a hedged approach, and then continue to learn how calls and puts work.
As you gain more understanding of options, you can start to experience the advantages, and potentially make some income, or protect yourself in the market. Options don’t have to be scary, but you do want to understand the strategies in order to really take advantage of the potential.
Make calculated decisions before you choose the strategy that is right for you, and then experience the potential gain when you choose right. It’s just getting started that takes some planning.
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