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Options trading is in the form of a contract given to a buyer, which gives them the ability to buy or sell an asset at a certain price or before a specific date. They are also known as derivatives because they derive their values from the price of something else, in this case, the price of the underlying asset. There are various options trading strategies to use like put strategy, call strategy, etc. but there are also certain options trading strategies to avoid.
With different strategies available, it is important to use an options strategy that will bring you the most profit with the lowest risk. Options can become a source of income and allow you to speculate and benefit from trading with lower risks of losing money. If you are looking for expert advice to provide you sound options trade alerts or options signals there are many services that do such that.
Here are some of the most common options trading strategies to avoid to ensure that you have the best profits possible.
Top 6 Common Options Trading Strategies to Avoid Or Use The Right Way
Buying Out of the Money Call Options
This strategy involves you buying options at low prices and selling them at higher prices. If you are looking to take part in options trading for a long period of time, you may end up losing more money instead of making a profit.
In order to ensure that this strategy works for you, you can use a covered call strategy that allows you to call option on a stock you already own. This reduces the risk that arises when you sell options when it is covered by a stock position. It is important to note that owning stock can also be a risky investment. This can be reduced by selling the stock if the market rises and exercising your call.
Delaying the Process of Buying Back Short Options
There are many reasons why investors delay the process of buying back short options that they have already sold. This can include not wanting to pay commission or betting that the contract will expire without any profits.
However, you must know when to buy back short options in order to reduce the risk of losing money in a way that will be profitable for you. One way to ensure that you do not lose money on buying back options is to buy it back when there is 80% or more of your initial gain from the sale of the option.
Trading Illiquid Options
When selling or buying options, there are different bid prices and ask prices. These prices often do not reflect the actual worth of the option. Rather, the actual value of the option will lie approximately in between the bid and ask prices.
Liquidity is a term used in the market that refers to the existence of active buyers and sellers at all times which bring heavy competition to transactions. Illiquidity is when there is an absence of these active buyers or sellers which can cause the bid and ask prices to widen. Therefore, while investing in options trading, it is advisable to look for stocks that are active which will ensure that they have higher liquidity.
Selling an Uncovered Call
Selling uncovered call options refer to selling call options against stocks that you do not own. This strategy is also sometimes called writing naked calls. The only way to guarantee profits from this strategy is when the price of the underlying stock is lower than the strike price on the expiration date of the option.
However, this cannot be guaranteed. The chances of the stock rising above the strike price are high with any kind of stock. If this happens, the owners of the option will most likely sell their option which will result in a loss at the lowest amount of the premium you receive from the option. However, if the stock prices continue to rise, you may have to buy the whole stock resulting in a larger loss.
Selling Uncovered Puts
Selling uncovered puts strategy is also known as writing naked puts. This strategy is not as risky as selling uncovered calls, but can also result in the loss of a substantial amount in comparison to a profit of any amount. This strategy involves offering the purchase of an underlying stock at a set price while you have no desire or aims to own it, nor have any resources available to purchase the stock should the option be exercised.
The only profit that you can get with this strategy is the amount of the premium that you will receive when selling the option. This is possible as long as the prices of the stock remain above the strike price. On the other hand, once the stock price drops, you may have to buy the stock at a price that may not seem worthy for the stock in question.
The short saddle strategy involves writing a naked call option and a naked put option at the same time and on the same stock. The stock must also have the same strike price as well as the same expiration date. You can get premiums from both transactions at once, thereby doubling your profit.
However, this strategy will work only if the stock trades within a narrow range. If the stock prices dramatically drop or increase, the risk of having a greater loss will increase. The short saddle strategy is one that gives you a limited reward with a higher risk of losses.
Options trading involves a variety of strategies that can bring you high profits as well as high losses. However, there are some strategies that seem to promise more profit while limiting your risks. It is, therefore, important that you pick a strategy that best suits your investing style as well as one that will reduce the risk of a loss while increasing the possibility of profits.