Our Business Experience
Forex

Stock Option Trading Strategies: What You Need to Know

Stock option trading lets investors trade on the future price movements of stocks without owning them. We explain some popular stock option trading strategies.

person holding a pen with stock options on a screen

Stock option trading allows investors to trade on the future price movements of stocks without having to own the stock itself. It offers flexibility, but also comes with risks. Here’s what you need to know about stock option trading and some of the most widely used strategies.

What are stock options?

Stock options are contracts that give an investor the right, but not the obligation, to buy or sell a stock at a predetermined price (called the strike price) before or on a specific date (the expiration date). There are two main types of options:

  • Call options: Give the holder the right to buy a stock.
     
  • Put options: Give the holder the right to sell a stock.

Options can be used for speculation or as a hedging tool. Now, let’s dive into some common strategies.

man in front of laptop writing on a notepad

1. Buying calls (bullish strategy)

This strategy is for traders who expect the price of a stock to rise. By buying a call option, the trader has the potential to profit from upward price movements. If the stock’s price rises above the strike price, the option becomes valuable, as it allows the buyer to purchase the stock at a lower price.

2. Buying puts (bearish strategy)

Buying a put option is a common strategy for those who expect the price of a stock to fall. The put gives the trader the right to sell the stock at a predetermined price, so if the stock’s price drops, the value of the put increases.

3. Covered calls (conservative strategy)

A covered call strategy is used by investors who already own the stock and want to generate extra income. They sell call options on the stock they hold. If the stock’s price stays below the strike price, the investor keeps the premium and the stock. However, if the stock rises above the strike price, they may be forced to sell the stock at the lower price.

Fund your trading account online with Skrill

4. Protective puts (hedging strategy)

If you own shares of a stock but are worried about a potential decline in its price, you can buy a put option. This gives you the right to sell the stock at a set price if the price drops. The trade-off is the cost of the premium.

person holding a tablet pointing at a chart

5. Straddles and strangles (volatility strategies)

Straddles and strangles are strategies for traders who expect a big price movement in either direction but aren’t sure which way it will go.

  • Straddle: Involves buying both a call and a put option with the same strike price and expiration date. This strategy profits if the stock moves significantly in either direction.
     
  • Strangle: Similar to a straddle, but the call and put options have different strike prices. The stock needs to move further to be profitable, but the upfront cost is lower than a straddle.

Both strategies can be risky, as they require significant price movement to cover the cost of both options.

6. Iron condor (neutral strategy)

The iron condor is a popular strategy for traders who believe a stock will remain within a certain price range. It involves selling both a call and a put option at strike prices near the current stock price, while simultaneously buying a call and a put further out of the money (strike prices farther away from the current stock price).

The goal is to profit from the lack of volatility (although this is never a guarantee), as the options will expire worthless if the stock stays within the range, allowing the trader to keep the premiums.

Risks of option trading

Option trading comes with unique risks. The most significant risk is the potential loss of the premium paid for the option, especially for out-of-the-money options that expire worthless.

Additionally, certain strategies, like selling naked options (selling an option without owning the underlying stock), can expose traders to unlimited losses. Options can also lose value quickly as they approach their expiration date due to time decay.

Stock option trading: A flexible approach popular with traders

Understanding these strategies, from simple buying and selling of calls and puts to more complex approaches like iron condors, is key to making informed decisions. Whether you are looking to hedge an existing position, generate income, or speculate on price movements, options can be a part of you stock trading strategy.

Open a Skrill account

The information provided on this blog is for general informational purposes only and is not intended to constitute professional financial advice. This article contains information about forex and trading; however this article and content does not constitute "advice", nor does it constitute any "recommendation" on whether or how to engage in forex and trading. The information contained in this article should not be relied on for any financial or other transaction.

Further, neither Skrill Ltd. nor any of its Affiliates, endorses or makes any warranties regarding the accuracy or reliability of any opinion, information, or statement provided throughout this article. All forex and trading content contained on or made available in this article is for educational informational, and/or advertising purposes only. Neither Skrill nor any of its Affiliates are licensed financial advisors and do not hold any licenses to provide trading or investment advice.

Skrill Ltd. does not endorse or promote any form of forex and trading. Please note that all forms of forex and trading (online and otherwise) carry with them inherent financial risk and risk of financial loss. Any forex and trading activities should be exercised with responsibility and moderation in compliance with all applicable laws and regulations.