Options Trading Strategies: Which One Should You Choose?
Options trading can be a complicated game. There are many strategies out there, and it’s hard to know which one is best for you. One strategy that has gained popularity lately is the “covered call.” This strategy was designed for investors who wanted to make money on stocks they already own (known as long stocks). When deciding which option trading strategies best suit your needs, here are some things to think about:
- What is my risk tolerance?
- What is my trading timeline?
- What is my ROI expectation?
Risk Tolerance
Lower Risk Strategies
These strategies typically have lower expected returns but help you sleep at night. Examples of these types of strategies are covered calls, protective puts, and collars.
As you can see, these strategies typically involve owning the underlying asset (stock, ETF, etc).
Covered Calls – This strategy involves owning an underlying asset while simultaneously selling call options on that same stock or ETF at a specific strike price. The goal of this strategy is to create income from your long position.
Protective Puts – This strategy involves buying an underlying asset and simultaneously purchasing protective puts at specific strike prices to limit the investor’s downside risks. The goal of this strategy is to protect against large losses in an underlying asset.
Collars – This strategy involves buying an underlying stock or ETF and simultaneously selling covered calls against that same position while also purchasing protective put options to limit downside risk. The goal of this strategy is to reduce costs associated with the long-stock position by offsetting the premium paid on the call option sold while limiting losses from a large drop in the underlying asset.
Medium Risk Strategies
These options trading strategies have higher expected returns but also involve more risk. Examples of these types of best options strategies are covered strangles, short puts, and bull call spreads.
Covered Strangle – This strategy involves selling an out-of-the-money (OTM) put and an out-of-the-money (OTM) call on the same underlying stock or ETF. The goal of this options strategy is to create income from a long position in an underlying asset while limiting downside risk.
Short Puts – This options trading strategy involves selling a put with a specific strike price and expiration date, without owning the underlying asset. The goal of this options trading strategy is to create income from selling put premium. If assigned with the underlying stock, the Wheel Strategy can be deployed.
Bull Call Spread – This options strategy involves buying a call with a specific strike price and expiration date, while simultaneously writing (selling) another call on the same stock or ETF with a higher strike price but also at the same expiration date. The goal of the strategy is to create income from call premium while limiting downside risk by utilizing the short call’s time decay.
Higher Risk Strategies
These options trading strategies involve high levels of risks, but also have the highest expected returns. Examples include selling naked calls/puts and selling strangles.
Selling Naked Calls/Puts – This options strategy involves writing (selling) an out-of-the-money call or put on a specific underlying stock or ETF without owning the underlying asset. The goal of this options trading strategy is to create income from selling premium, while also taking advantage of time decay for short calls and puts.
Selling Strangles – This options trading strategy involves selling OTM put and call options on the same underlying stock or ETF. It’s essentially a combination of selling naked put and call at the same time. The goal of this strategy is to create income from premiums. The Tasty Trade method utilizes this strategy.
My Take on Risk Tolerance
When it comes to how much risk we are willing to take, a lot of it is phycological and what is perceived as risks.
For example, selling a naked call is considered the most dangerous form of options trading because it has unlimited risk. However, when managed properly, the actual risk is not as high as someone thinks.
Having said that though, in practice, knowing that it has unlimited risk, you might not be able to act properly to make the trade profitable. Trust me, I have encountered this many times.
This is why I try to find a strategy that matches my risk perception and the actual risk. In other words, a trading strategy that matches my personality.
Trading Timeline
Since options have an expiration, depending on which side of the trade you are on (buying or selling), time decay can be on your side or against you.
If you are selling options, time decay is on your side. If you are buying options, then the passage of time can be against you as it will decrease the value of your option premium.
My Take on Trading Timeline
I personally prefer strategies that sell option premium because even if the stock doesn’t move in the expected direction, the options could expire worthless for me to make money.
ROI Expectation
Many options traders started out trading stocks but eventually moved on to trade options because when trading options, it is possible to generate a consistent income without the need for directional moves of the underlying stock. Whereas stock traders need the stocks they are trading to move one way or the other to make money.
On the other hand, there are traders who want to bet on a directional move by using options to amplify returns on their limited capital rather than buying the underlying stocks.
My Take on ROI Expectations
As I mentioned, I personally prefer to sell option premium rather than buying options.
The downside to these kinds of options strategies is that they tend to have lower ROI compared to strategies that buy options.
So what is the Best Option Strategy?
I think the best options strategy is one that fits your personality and risk tolerance. I am not as concerned with ROI because even if ROI from each trade is low, just simply repeat the same type of trades will generate enough ROI to get me excited.
For me, I would choose to sell option premium because it gives me consistent income even if there are no directional movements in the underlying stock or ETF.
