Derivatives are an important part of financial markets as they can help reduce the risk and/or enhance the return of a portfolio. Options are a derivative that gives the buyer the right to buy or sell a security at a specified price. Call options provide the right to buy and put options provide the right to sell (before expiry date).
There are 3 intermediate strategies that can help one gain more control over a portfolio. See below:
Options Strategies
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Covered Call – A covered call is a strategy in which stock is purchased (or owned) and calls on the underlying stock are sold on a share-for-share basis. This is a popular strategy because it generates income and reduces some risk of being long on the stock. The trade-off is that one must be willing to sell their shares at a set price—the strike price. Traders may choose to use this strategy when they have a short-term position in a stock and a neutral opinion on its direction.
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Married Put – A married put is a strategy in which stock is purchased and put options are simultaneously purchased for an equivalent number of shares. A trader may use this strategy to protect their downside risk when holding a stock. This strategy can act as insurance on a stock and it establishes a price floor if the stock falls significantly.
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Bull Call Spread – A bull call spread is a strategy in which a trader buys calls at a specific strike price while also selling the same number of calls at a higher strike price, on the same stock and expiration date. One may use this strategy when they are bullish on the underlying stock and expect a moderate price rise. This strategy is successful when the stock increases in price in order to make a profit on the purchased call option, however, the trade-off is that one’s upside is limited. When call options are expensive, you can offset the high premiums by selling higher strike calls against them.
These strategies can help traders reduce their risk in a portfolio while also providing some additional yield through option premiums. However, it’s important to note that these strategies can also open one up to additional risks. Market participants should be aware of the profit and loss potential on every trade that they put on.
