Options: Part Two

In part one, we talked about what options are and discussed their features on the Binance exchange.

In this article, we will examine the most popular trading strategies in detail and categorize them depending on the investor’s goal.

Call Option Buy

The essence of the strategy lies in profiting from an expected steady increase in the price of the underlying asset above a certain level. At the same time, maximum losses are limited.

The fact that the losses are limited while profits are not is the main advantage of this strategy. As can be seen in the graph above, losses are limited by the premium paid for the option. At the same time, the profit has no limit and depends solely on the growth of the price of the underlying asset.

Put Option Buy

The essence of the strategy lies in profiting from an expected decline in the price of the underlying asset below a certain level. At the same time, maximum losses are limited.

As in the previous strategy, the loss is limited by the premium paid for the option, while the profit has no limit.

Call Option Sell

The essence of the strategy lies in profiting from the forecast that the price of the underlying asset will be below a certain level at the time of expiration. The risk of this strategy is if the market moves in an unexpected direction, our loss will have no limit.

Put Option Sell

The essence of the strategy lies in profiting from the forecast that the price of the underlying asset will be above a certain level at the time of expiration. If the outcome is unfavorable, our loss will have no limit.

Selling a put option is profitable if you expect a slight increase in the price of the underlying asset: it should be higher than the strike price at the time of expiration.

If a significant increase in the value of the underlying asset is expected, then buying a call is a more attractive strategy. An intensive price increase will quickly cover the premium paid, while further growth will make high profits possible.

Selling a call is also a major strategy in case of a slight price drop expectation.

Options combined with trading the same instrument on spot or futures exchange accounts can be an excellent way to “hedge” your trading!

Additionally, you can combine many option types to create scenarios that can cover every possible market scenario.

These four strategies are the basis for options trading. Below is a table that contains all the essential information on profit and loss associated with the execution of these strategies.

Synthetic Futures Long

The essence of the strategy lies in profiting from moderate growth above a certain level. At the same time, we expect that the price is unlikely to fall significantly after the option has been purchased, in this case, our loss would have no limit.

Strategy components: Long call + Short put

Synthetic long (bullish) futures are based on buying a call and selling a put with the same strike price.

The yield chart is a straight sloping line. The breakeven point corresponds to the strike price of the options: the received put bonus is offset by the paid call premium.

Synthetic Futures Short

The essence of the strategy lies in profiting from a moderate drop below a certain level. At the same time, we expect that the price is unlikely to increase significantly as our loss would have no limit.

Strategy components: Short call + long put

Synthetic short (bearish) futures are the opposite of the long ones; the breakeven point corresponds to the strike price of the options as well, while both profit and loss are unlimited. Everything is exactly the same as with classic futures.

Bull Call Spread

The essence of the strategy lies in profiting from a slight increase in the price of the underlying asset. At the same time, the strategy is focused on limiting the possible profit and loss.

Strategy components: Long call A + Short call B

This strategy is based on buying a call (A) with a lower strike and selling a call (B) with a larger strike at the same time. It is expected that at the options expiration time, the price of the underlying asset will float between the strikes A and B.

The investor expects a slight increase in the price of the underlying asset, therefore, in addition to receiving income from the underlying asset price rise, he also expects to earn the premium from selling a call, assuming that the strike of the short call (B) will not be reached.

The loss is limited by the difference between the prices of option A and option B, which is marked as area 1 on the chart. Note that market premium A (which the investor pays) will be higher than premium B (which the investor receives), since the higher the strike is, the less likely the price is to rise to its value.

Bear Put Spread

The essence of the strategy lies in profiting from a slight drop in the price of the underlying asset. Moreover, our potential profit and loss are limited.

Strategy components: large strike put (B) buy, small strike put (A) sell.

Area 1: the additional income generated by Put B is offset by the corresponding loss from Put A (we pay to buyer A);

Area 2: income on purchased put B is growing;

Area 3: a loss is equal to the difference between premium B (loss) and premium A (gain);

Bear spread strategies are used if a slight fall in the price of the underlying asset is expected, while bull spread strategies are executed when the opposite scenario is expected. If the forecast plays out, these strategies provide a more attractive profit than the usual buy or sell of an option. Possible profits and losses while executing these strategies are limited.

Straddle Buy

The essence of the strategy lies in gaining maximum earnings during times of increased volatility.

Strategy components: Long call A + Long put A

The strategy is to buy put and call options with the same strike price and contract expiration date. Profit is not limited and arises when the underlying asset moves in any direction. High volatility is the best friend of this strategy. Losses are limited to premiums paid for two option contracts.

Straddle Sell

The purpose of the strategy is to maximize earnings during times of low volatility.

Strategy components: Short call A + Short put A

The strategy is to sell put and call options with the same strike price and contract expiration date. As you can see, the profit on this strategy is limited, but the loss, on the contrary, has no limit and depends on the degree of the volatility of the underlying asset. It is worth using this strategy when you expect a decrease in market volatility; that is, the movement of the underlying asset will occur in a certain channel.

Conclusion

As you can see, options are an incredibly useful tool that provides a lot of opportunities to generate profit. Using different strategies, you can find a way to make a profit in almost any scenario.

Do not forget that it is important to carefully check every calculation made and ensure that you are confident of your decision before going into any trade.