Other Options Trading Strategies
The most commonly used options trading strategies are those that are designed to try and generate profits when a trader has a specific outlook on a financial instrument:bullish, bearish, neutral or volatile. Options are very versatile trading instruments though and there's a range of additional ways that they can be used to make money, and also for other purposes such as hedging or adjusting an existing position.
While you may not use most of these additional strategies too often, it's certainly useful to familiarize yourself with them because there may be times when you will want to utilize them. We have provided information on a number of alternative trading strategies, in several different categories. You can see below for more details.
In very simple terms, arbitrage defines circumstances were price inequalities means that an asset is effectively underpriced in one market and trading at a market price in another. Basically, arbitrage exists if it's possible to simultaneously buy an asset and then sell it immediately for a profit.
Such scenarios are obviously hugely sought after, because they provide the potential for making profits without taking any risk; however these scenarios are somewhat rare and are often spotted earlier by professionals at the big financial institutions.
They do occur occasionally in the options market though, primarily when an option is mispriced or when accurate put call parity is not maintained, and it's possible to find them and take advantage.
For more information on arbitrage and put call parity, along with details of options trading strategies that are specifically designed to profit from arbitrage opportunities such as strike arbitrage, the box spread, and reversal arbitrage please visit this page.
Synthetic Trading Strategies
Synthetic trading strategies are essentially an extension of synthetic positions. A synthetic position is essentially a position that recreates the characteristics of another trading position by using different financial instruments such as an options position that has the same characteristics as holding stock.
Strategies that use a combination of options and stock to emulate other trading strategies are said to be synthetic. They are typically used to adjust an existing strategy when the outlook changes without having to make too many additional transactions.
The three most commonly used ones are the synthetic straddle, the synthetic short straddle, and the synthetic covered call. For more information on these please click here.
Protective Puts & Protective Calls
Protective puts and protective calls are trading strategies that use options to protect existing profits that have been made, but not realized, from either buying or short selling stock.
The basic principle is that, when a long stock position or a short stock position has performed well, a trader can use a protective put or a protective call respectively to preserve the profits that already have been made in the event of a reversal, but also allow continued profitability should the stock continue to move in the right direction.
As a simple example, imagine you bought a particular stock at $10, and the price then rose to $15. If you wanted to be able to profit from further price increases, but also safeguard against the price dropping back down, then the protective put will help you do this. It's essentially a straightforward hedging technique.
For more information on protective puts and protective calls, please visit this page.
Delta Neutral Strategies
Delta is one of the five main Greeks that influence the price of options. It's in fact widely considered the most important of these, because it's a measure of how much the price of an option will change based on the price movements of the underlying security.
Delta neutral strategies are used to create positions where the delta value is zero, or close to it. Such positions aren't affected by small price movements in the underlying security, meaning there's little directional risk involved. They are typically used to hedge existing positions or to try and profit from time decay or volatility.
Please click here for more detailed information on how these strategies can be used.
Gamma Neutral Strategies
Gamma is another of the Greeks; the gamma value of an option measures the sensitivity of the option’s delta value compared to price changes in the underlying security. Gamma neutral strategies are designed to create trading positions where the gamma value is zero or very close to zero; which would mean that the delta value of those positions should remain stable regardless of what happens to the price of the underlying security.
They can be used for a number of purposes, such as reducing the volatility of a position or attempting to profit from changes in implied volatility. They can also be combined with delta neutral strategies for more stable hedging. You find out more information on them here.
Stock replacement is an investment technique that aims to closely match the potential returns of holding stocks by using a different financial instrument, or combination of financial instruments. It's typically used for one or more of a number of reasons that include reducing the amount of capital required, increasing the potential profits, limiting losses, and freeing up extra funds that can be used for hedging purposes.
One of the most commonly used stock replacement strategies involves buying calls instead of buying stock, and this has a number of advantages. It's actually a very simple strategy, and even complete beginners should have no problem using it. More advanced traders can also use hedging techniques to further limit the risks and volatility that are involved.
You can read about using options for stock replacement here.
Even the best investors will make trades that don’t turn out as planned from time to time, and a key part of successful investing is recognizing that limiting losses is just as important as maximizing profits. Although sometimes it's best to simply cut your losses and exit a losing position, equally there will be occasions when there are alternatives that may be worth considering.
Stock repair is a technique that stock traders can employ, using options, to increase the chances of recovering from being long on a stock that has fallen in price. When used correctly, it's possible to break even from a smaller price increase in the stock than would otherwise be possible, without having to commit any more capital.
Although this sounds like it might be quite hard to do, in reality stock repair using options is actually quite simple. To find out more about how and when to use this technique, please visit this page.
Married Puts, Fiduciary Calls & Risk Reversal
The final three strategies we have included are married puts, fiduciary calls, and risk reversal strategies. These aren't among the most widely used so we haven't covered them in a great deal of detail. However, you may have an occasion to use them so it's worth spending a little time familiarizing yourself with them. They are all relatively straightforward and have fairly specific purposes.
The married put combines a long stock position with a long put options position on the same stock. It is, in essence, the same as a protective put but it's executed differently and is not used for precisely the same reasons. It involves making the two required transactions (buying stocks and writing puts) at the same time, and is used primarily to limit the potential risks involved in buying stocks.
The fiduciary call involves buying calls and also investing capital into a risk free market such as an interest bearing deposit account. In some respects, it's a stock replacement technique, but again it actually serves a slightly different purpose, beecaus its chief function is to effectively reduce the costs involved with buying and exercising calls.
Risk reversal is a phrase that has two meanings in investment terms. It can be used to refer to a strategy involving options that is employed, commonly in commodities trading, because it's a hedging technique used to protect against a drop in price. It's also used in forex options trading as a term to describe the difference in implied volatility between similar call options and put options.
For more detailed information on risk reversal, and married puts, and fiduciary calls: please click here.