Options trading is a complex and demanding undertaking. Many traders know the basics, such as buying puts and calls to hedge their portfolios or speculate on rising and falling markets.
However, more advanced strategies are available for experienced traders looking to take their game to the next level.
This article discusses some powerful tactics for listed options trading in the UK. Each strategy is detailed below to provide an overview of its associated risks, benefits, and potential profits.
1. Covered call writing
Covered call writing is a popular options trading strategy many experienced UK traders use. The strategy aims to generate income from options premiums while limiting downside risk.
It involves writing call options against an underlying asset, such as stocks, ETFs, or indices, with the trader receiving options premiums in exchange for agreeing to sell the underlying asset at a predetermined price (the strike price).
This strategy can be highly profitable if the options are correctly priced and managed; however, risks are associated if the underlying asset moves unexpectedly.
2. Protective puts
Protective puts involve ‘putting’ options on an existing long portfolio position that has been held for some time. In essence, a trader purchases options that give them the right to sell their underlying asset at a predetermined price (the strike price) in the future.
It allows the trader to protect themselves against potential losses if the market moves lower than expected while allowing them to benefit from any upside movement.
This strategy is often used when traders are unsure of what will happen next and want to hedge their position against potential losses.
3. Straddles and strangles
Straddles and strangles are advanced options trading strategies designed to take advantage of high volatility in an underlying asset. A straddle involves buying both call options and put options with the same strike price, while a strangle involves buying options with different strike prices but the same expiry date.
These strategies can be highly profitable if the trader correctly predicts a significant move in price; however, there is also a risk of loss if the options expire with no profit made.
Additionally, as options have time decay, these strategies should only be used when a significant amount of time remains until expiry.
An options spread is a strategy involving the simultaneous purchase and sale of options with different strike prices but the same expiry date. These are typically used to reduce risk or take advantage of pricing discrepancies in options.
For example, a trader may buy an option at a lower strike price and sell an option at a higher strike price, resulting in a net credit if the options expire in the money. This strategy can be highly profitable for experienced traders who correctly predict market movements.
Moreover, options spreads can also speculate on the market direction without purchasing the underlying asset.
5. Butterfly spreads
A butterfly spread is another options trading strategy that involves buying call options and put options at three different strike prices. The options must have the same expiration date and be bought in equal quantities.
It allows traders to profit from options premiums while limiting their risk. If the options expire in the money, the trader can earn a substantial return on their investment. On the other hand, there is also a risk of loss if options expire out of the money or with a time value loss.
Furthermore, options spreads should only be used by experienced traders who understand the implications of options pricing and volatility.
6. Calendar spreads
Calendar spreads involve purchasing and selling options with different expiration dates but the same strike price. This strategy is typically used when there is a discrepancy between options prices due to differences in implied volatility or time decay.
By buying options with further expiry, traders can take advantage of options premiums while limiting risk. However, it is crucial to understand that options have time decay and, as such, calendar spreads should only be used when sufficient time remains until expiry.
Moreover, options pricing can be pretty complex, and traders should ensure that they understand the implications of options volatility before attempting this strategy.