Option Trading Strategies For Beginners

Instead of trying to comb through 64 different strategies every time you want to place an options trade you can use this method to make sure you have the right strategy for the right situation. Anytime you can trade with an edge in your favor you are setting yourself up for long-term success. 

1. If you are bullish with low volatility:

Long Call. The long call is the vanilla trade of the options world. You are making a sure bet that the stock price will increase. If the stock price increases and you get an increase in volatility your position will benefit much more.

Bull Call Spread. These are debit spreads that are formed by buying one call and selling another call at a higher strike at the same expiration. We use a spread to lower the cost of the position, but it means our max profit is limited.

Call Calendar Spread. Time spreads or calendar spreads are more complicated because they involve selling a call option at one expiration and buying another call at the same strike but at a later expiration. Calendar spreads are good if you are expecting a little movement in the underlying opposed to a large move higher.

Long Ratio Call Spread. Anytime you see ratio in options you know you are buying or selling different amounts of options. For this spread you want to sell 1 lower strike call option for every 2 higher strike call options you buy. This trade actually benefits if you get a large move lower or a large move higher. Now if the underlying moves lower your gains will be minimal and capped, but if your underlying moves higher your gain is unlimited.

2. If you are bullish and there is high volatility, use these strategies instead:

Short Put. When you short a put option you receive a credit for the position, and this will be your max profit. You want to sell a put that is out of the money and then have the underlying stay above that strike by expiration. If that happens you collect your full credit. When volatility drops your position will begin to make money.

Bull Put Spread. Bull put spreads work the same way a short put does except you are selling a put option and then buying another put option at a lower strike. Your max profit will be capped at the credit you receive, but your loss will also be capped by the difference between the two strike prices.

3. When you are bearish, and there is low volatility:

Long Put. The long put is the vanilla trade of the options world. You are making a sure bet that the stock price will decrease. If the stock price decreases and you get an increase in volatility your position will benefit much more.

Bear Put Spread. These are debit spreads that are formed by buying one put and selling another put at a lower strike at the same expiration. We use a spread to lower the cost of the position, but it means our max profit is limited.

Long Ratio Put Spread. For this spread, you want to sell one at the money strike put option for every two lower strike put options you buy. This trade benefits if you get a large move higher or a large move lower. Now if the underlying moves higher your gains will be minimal and capped, but if your underlying moves lower your gain can be substantial.

Put Calendar Spread. Time spreads or calendar spreads are more complicated because they involve selling a put option at one expiration and buying another put at the same strike but at a later expiration. Calendar spreads are good if you are expecting a little movement in the underlying opposed to a large move higher.

4. When you are bearish but volatility is high, go for these strategies:

Short Call. When you short a call option you receive a credit for the position, and this will be your max profit. You want to sell a call that is out of the money and then have the underlying stay below that strike by expiration. If that happens you collect your full credit. When volatility drops your position will begin to make money.

Bear Call Spread. Bear call spreads work the same way a short call does except you are selling a call option and then buying another call option at a higher strike. Your max profit will be capped at the credit you receive, but your loss will also be capped by the difference between the two strike prices.

5. When you are neutral with high volatility:

Short Straddle. When you are absolutely certain the stock is not going to go anywhere you want to use a short straddle. These positions are created by selling a call option and a put option at the same strike (typically at the money) and expiration. You will collect the full credit if the underlying stays at the strike price by expiration. If the underlying makes any large moves at all this position will be a loser. This position will benefit greatly if volatility begins to drop.

Short Strangle. A short strangle is a lot like a short straddle, but now you are selling a call option that is out of the money and a put option that is out of the money, both at the same expiration. This strategy is going to give you a wider range that the stock can move while still holding a gain but will lower your profit potential.

Iron Condor. An iron condor is an advanced strategy because it requires four different options to be placed. You will be selling a bull put spread, and a bear call spread at the same expiration. This creates a wide range for the stock to move (like a short strangle) but instead of having unlimited loss potential like the short straddle and short strangle your loss will be capped.

6. How about when you are neutral, and there is low volatility? In this case, you don't want to place any trades. You have no real advantage if you try a short straddle, short strangle, or iron condor in this situation. If volatility begins to rise it will cause losses in all of those positions. These are trades you want to avoid because there is no edge.

Remember if your implied volatility percentile is between 30-70 or if you are neutral and the percentile is between 0-30 go ahead and skip those trades. These situations don't give you an edge and don't set you up for long-term success.