Wednesday, 8th September 2010

Option Strategies

Written by George Traganidas Topics: Options, Wealth Building

Option Strategies

There are a lot of option strategies and each one of them should be used in the appropriate situation. The guide below is a summary of a series of articles about the stock strategies. This summary will help you to identify which strategy to use in which situation so you can maximise your profits and reduce your loses. I will update the list below as a find new information about the strategies or as I learn new ones.

Why buy calls?

  • You believe a stock has a strong catalyst for appreciation over the coming months or few years.
  • You want to benefit from a stock’s upside, but put less capital at risk than buying the stock outright.
  • You want to leverage your bullish expectations on a stock you already own.

Why buy puts?

  • You believe a stock is ripe for a fall and want to profit if it declines.
  • You want to hedge against the bullish positions in your portfolio.
  • You want to protect a position in your portfolio that you’re bullish on from a near-term downward move.

Why write puts?

  • Income: To make money while waiting for your preferred buy price on a stock.
  • Advantage: To buy stocks at a lower net cost.
  • Profit: To earn income from stocks you believe will hold steady or increase modestly.

Why use covered calls?

  • Income: To generate cash on a stable stock.
  • Defense: To profit if a stock you own slips in price.
  • A better sell price: To obtain a higher price when you’re ready to sell.

Why use protective collars?

Protective collars are useful in bear markets or when you’re uncertain about a stock’s valuation risk. They can also be a prudent way to protect your gains on stocks that have recently leaped in price, nearing your estimate of fair value.

Why use synthetic longs?

This option strategy works nearly the same as owning the underlying stock outright — except you don’t need to pay up front. Usually, you’ll set up a synthetic long on a stock if you foresee a strong catalyst for appreciation in the next 18 months or so.

Why use synthetic shorts?

If you’re looking to profit when stock prices slip, there’s a way to use options to mimic shorting a stock — but with distinct advantages.

Why use stock repair?

  • You are down 15% to 25% on a stock and willing to forego profits to sell at breakeven.
  • Not interested in averaging down or holding for the long haul.
  • Using a margin-approved account and can write call options.

Why use diagonal calls?

  • If you’re mildly bullish on a stock and want to generate income from a leveraged investment.
  • To profit from a range-bound stock.
  • If your underlying stock is chosen well, and you’re handed a little market luck, you can wake up a year or two hence with a significantly in-the-money call option that effectively costs you nothing.

Why buy a straddle?

  • You believe a stock or index will move dramatically, but you don’t know which way.
  • You believe volatility will increase in general, so the value of the options you’re buying will increase.
  • You want to leverage potential returns when the underlying investment moves meaningfully in either direction, but limit your risk.

Why write a straddle?

  • You believe a stock or index is going to hold steady or stay in a tight range.
  • You believe a stock that was recently volatile will settle down considerably.
  • You believe the market’s overall volatility is going to decrease.

Why use bull call spreads?

  • Capital gains: To profit on a stock you feel relatively bullish on.
  • Defense: To limit your capital at risk and lower your break-even point compared with just buying calls alone.
  • Leverage: To land an oversized potential return on your net cost, although you sacrifice additional upside.

Why use bearish spreads?

  • To profit on a falling stock or index while capping your risk.
  • To earn strong percentage returns on a moderate move in an underlying investment.
  • To lower the cost of bearish put option purchases.

Follow the practical way,
George Traganidas

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