Neutral Market Trading Strategies
A major reason why trading options is so popular is because of the number of opportunities there are for making profits. For example, unlike other forms of investment, options give traders the chance to profit when an underlying security remains neutral i.e. it doesn’t move in price.
This function is unique to options, because there are no other financial instruments that can be traded to generate profits from a lack of price movement. There are a large number of neutral options trading strategies (also known as non-directional strategies) that can be used when you have a neutral outlook on an underlying security, and if you can gain a good understanding of these then you will open up many opportunities for making profits.
On this page we explain the concept of a neutral trend and discuss the advantages and disadvantages of using neutral trading strategies. In addition, we provide a list of strategies that you can use to profit from a neutral outlook.
- What is a Neutral Trend?
- Advantages of Neutral Strategies
- Disadvantages of Neutral Strategies
- List of Neutral Strategies
What is a Neutral Trend?
In investment terms, the word neutral is generally used to describe a financial instrument that doesn’t move in price. While this is technically accurate, in the context of options trading the word has a slightly broader meaning. When we talk about neutral trading strategies, we are talking about strategies that not only profit from an underlying security staying at the same price but also profit when that security moves within a tight range of prices.
When the price of a security goes up and down by small amounts over a period of time, it's said to be moving sideways. This is because if you plotted the price movements on a graph, the graph line wouldn’t show any real incline or decline, but it would basically be moving sideways. When a price is moving sideways the underlying security is in what's known as a neutral trend.
During such a trend the price of the underlying security is consistently going up and down, but not usually by a huge amount and it's always remaining with a certain range. A neutral trend will typically occur after a sustained increase in price or a sustained decrease in price when the price starts hitting levels of resistance or support accordingly.
These trends can continue for weeks or even months at a time. Stock traders and other investors will really struggle to profit under these circumstances and they will typically leave securities that are in a neutral trend alone. However, options traders can take advantage of them by using appropriate strategies.
Advantages of Neutral Strategies
The biggest advantage of neutral options trading strategies is really the simple fact that they exist. Being able to profit from stocks and other financial instruments that remain relatively stable in price gives investors who use options many more opportunities than those who don’t.
Many financial instruments go through prolonged periods of being neutral, or in a neutral trend, and this gives options traders plenty of chances to generate returns. It's somewhat obvious that the more potentially profitable opportunities there are, the greater the chance there is of being successful on a consistent basis.
The other main advantage of these strategies is that by using them you can profit from three different outcomes. If the underlying security doesn’t move at all, you will make a profit. If the underlying security increases in price or decreases in price, you will still make a profit, providing the price movements stay within an appropriate range.
Some strategies need the price of the underlying security to remain in a very tight range to return a profit, while others can profit from a wider range. To some extent, you can control just how wide you want the range to be and this is another example of just how flexible options trading can be.
Other advantages include the fact that you can turn time decay into a positive and also control your risk exposure to some extent. When using some of the more basic strategies, it's very simple to work out the maximum potential profit and maximum potential loss, and this can be very useful for when planning trades and managing risk.
Finally, the fact that there are so many different strategies you can use means you have plenty of choice and a good chance of finding one that fits well with your personal objectives.
Disadvantages of Neutral Strategies
There isn’t many major disadvantages when it comes to using strategies of this type. The biggest drawback is the fact that the potential profits of these is always limited, because the maximum amount of profit that can be made from any trade is essentially fixed at the moment it's executed.
Another disadvantage is that the strategies all require at least two transactions, and some of them more, so you will potentially pay a fair amount in commissions. This is actually true of most options trading strategies. Also, some of them can be quite complicated and certainly not suitable for beginners.
These disadvantages are all relatively minor though, and it should be clear that they are far outweighed by the benefits.
List of Neutral Strategies
Below, we have listed a range of neutral options trading strategies that are commonly used by options traders. We’ve included a little information about each one, but for further details you should click on the relevant link. If you are struggling to choose a suitable strategy, you may like to take a look at our Selection Tool.
This is relatively simple and would typically be used if you already own a security and want to profit from it being in a neutral trend. It's suitable for beginners.
This is fairly simple and you would generally use it if you already own a security and want to profit from it being in a neutral trend and protect it against any losses should it fall in price. It is suitable for beginners.
This is reasonably complex and combines short selling a security and writing put options. It's not suitable for beginners.
This is a relatively simple trading strategy, but it's not really suitable for beginners due to the high trading level required. It involves two transactions and creates a credit spread.
This is quite straightforward but requires a high trading level so it's not suitable for beginners. It creates a credit spread and involves two transactions.
This combines two transactions to create a credit spread. It's quite simple, but it requires a high trading level meaning it isn't suitable for a beginner.
This is simple enough to be used by beginners. Two transactions are involved and a debit spread is created.
This is straightforward and involves two transactions. It creates a debit spread and is suitable for beginners.
This is a complicated trading strategy that is not suitable for beginners. There are two transactions involved and a credit spread is created.
This is complex and not for beginners. It creates a credit spread with two transactions.
This involves four separate transactions to create a debit spread. It isn't suitable for beginners.
This creates a debit spread. There are four transactions involved and it isn't suitable for beginners.
This is complex and involves three transactions to create a debit spread. It isn't suitable for beginners.
This is complex and it creates a debit spread using four separate transactions. It isn't suitable for beginners.
This involves four transactions and is complicated. It creates a debit spread and is not suitable for beginners.
This is complex and creates a credit spread. It involves four transactions and it's not suitable for beginners.
This is complex, involving four transactions, and it's not suitable for beginners. It creates a credit spread.
This is complicated and not suitable for beginners. It involves four transactions and creates a credit spread.