Option buying strategies involve purchasing options to profit from anticipated price movements in the underlying asset. Here are some common option buying strategies explained in simple terms for novice traders:
Long Call:
- When you buy a “long call” option, you gain the right, but not the obligation, to buy the underlying asset (e.g., a stock) at a specific price (strike price) before the option’s expiration date.
- You buy a long call when you expect the price of the underlying asset to rise significantly. If the asset’s price goes up, you can exercise the option and buy the asset at a lower price than its market value, making a profit.
Long Put:
- With a “long put” option, you acquire the right, but not the obligation, to sell the underlying asset at a fixed price (strike price) before the option’s expiration date.
- You buy a long put when you believe the price of the underlying asset will decrease substantially. If the asset’s price falls, you can exercise the option and sell the asset at a higher price than its market value, resulting in a profit.
Long Straddle:
- A “long straddle” involves buying both a call option and a put option with the same strike price and expiration date.
- You use this strategy when you expect significant price volatility but are unsure about the direction in which the asset’s price will move. If the asset’s price makes a significant move in either direction, one of the options will become valuable, and you can profit from it.
Long Strangle:
- A “long strangle” is similar to a long straddle but involves buying a call option with a higher strike price and a put option with a lower strike price, both expiring on the same date.
- This strategy is also used when you anticipate substantial price volatility but are unsure about the direction of the price movement. It allows you to profit if the asset’s price moves significantly, regardless of whether it goes up or down.
Covered Call:
- In a “covered call,” you purchase the underlying asset (e.g., stock) and simultaneously sell a call option on that asset.
- This strategy is relatively conservative and used when you want to generate extra income from an asset you already own. If the asset’s price remains stable or slightly increases, you keep the premium from selling the call option as profit.
Remember that while option buying strategies offer the potential for significant gains, they also involve the risk of losing the premium paid for the options. It’s essential to understand the risks and consider your risk tolerance before using any option buying strategy. Beginners should start with simpler strategies and gradually move to more complex ones as they gain experience and understanding of the options market.