Best option trading strategies for beginners

0

Of late, option trading has become very popular and constitute the lion’s share of daily trading volume in our exchanges. Among options traders, most of the high volume trades are done by the institutional traders and HNIs. That said, lots of retail investors also trade in options. Some of the retails traders are well equipped to trade options. And there are others who try to trade options like the equities and some are beginners. In this article we are going to discuss some of the best option trading strategies for beginners.

Intraday or Swing? What is the best choice for options trading for beginners?

We all know that options have limited life span. We have weekly options which have a life span of 7 days, monthly options which have a life span of 28 days. But for index options and commodity options we have options which have life span of 2 months, 3 months, 6 months and more.

Most option trading strategies for beginners focus on weekly and monthly options. The Bank Nifty option trading for beginners also prefer weekly options. On a related note, you might want to check out our primer on options basics.

Traders who want to make money through buying options, should go for intraday trades. Because, the options which have short life span lose premiums very fast due to theta decay, on a daily basis.

But many traders sell options for hedging and for eating premium through theta decay. These traders may keep the trade open till the options expire. These are swing traders.

It has been seen that many traders who are beginners prefer to buy options seeing the prospect of unlimited profit. But it must also be mentioned that options buyers practically lose money most of the times. Therefore our strategies will be mainly centered around combination strategies.

Option trading strategies for beginners

Here are a few option trading strategies for beginners. These strategies are also used for Bank Nifty option trading for beginners. There are many option strategies that traders use. Some of them are complicated strategies, many of them are situation-based strategies.

Shown below are most popular and comparatively safer strategies which are versatile too. The beginners can easily implement these strategies and will also get margin facilities. These are risk adjusted strategies most suitable for the beginners.

Covered Call

This is a combination strategy. In this strategy, we take a long position in a stock or future and write a Call of nearby strike price.

Supposing the price of a stock or future is INR4,900. We buy one lot of a future or in cash segment. We can either buy the stock or one lot of future. Say we bought 100 shares at INR4,900 or bought one lot of futures at INR4,900 comprising of 100 shares.

And we sold one lot of Call (100 shares per lot) at the strike price of INR5,000.

Why did we take this strategy? We expect the stock to go up further. In case the stock price comes down, the sold Call will protect us.

If the stock goes up, we will square off the option at INR5,000. Then we will lose a little money from the call option, but the rise in stock price or the future price will adequately compensate the loss.

The projected P/L (profit and loss) diagram of a covered call looks like this.

Covered Call among the best option trading strategies for beginners
Option trading strategies for beginners – Covered Call

Assuming we bought the Call option for INR70 each, we get a big range of price which is profitable for us. During expiry, if the stock price comes down to even INR4,830, we don’t lose money. It is a no profit – no loss zone. After that we profit till the price goes up to INR5,400. At INR5,000, we get maximum profit. Below INR4,830, we lose money.

Read Also: Best Indicators for Options Trading

Protective Put

The protective Put is another combination strategy. In this strategy, we buy the stock or futures and also buy a Put. In a Protective Put strategy, the downside is limited to the premium paid of the Put while upside is unlimited.

Similar to the previous example, we buy the stock/ future at INR5,000 and also buy a Put of INR4,900 at a premium of INR70.

Now let us look at the P/L diagram below.

Protective Put
Protective Put

We can calculate the P/L here. The total cost price of stock + Put = INR5,000+INR70 = INR5,070. So INR5,070 is our break even price above which we are going to make profit.

Below INR 5,070 is our loss making area till INR 4,900, when the maximum loss of INR 170 is reached. Options trading for beginners need to be easy to understand and this strategy fits the bill perfectly.

Straddle

The straddle is a combination strategy of Call and Put of the same strike price. The Straddle can be either Long or Short.

In a Long Straddle, we buy both the Call option and the Put option of same strike. We take this strategy when we expect high volatility and a big jump in price either way. Such price behaviors can be seen before a big event (like annual budget) or before yearly result when important announcement is expected to be made.

The P/L diagram of a Long Straddle looks like this.

Long straddle options trading for beginners
Long Straddle

Say, we bought the Call at INR70 and bought the Put at INR40. Both the Call and the Put were of the INR5,000 strike price.

So, the cost price is = INR70 + INR40 = INR110

Hence, the break even on the upper side is INR5,000 + INR110 = INR5,110 and break even at lower side is INR5,000 – INR110 = INR4,890.

If the stock price hovers between INR4,890 and INR5,110, we don’t get any profit. But, if the stock goes beyond this price range, we can have unlimited profit making it among the best option trading strategies for beginners.

The maximum loss is INR110 if the stock remains at INR5,000. This is the Long Straddle strategy.

In a Short Straddle strategy, we write both the Call and the Put at the same strike price. Our maximum profit will be the premium we collected during writing the options which is INR110 at INR5,000 stock price during expiry.

Short Straddle
Short Straddle

An option seller retains this profit if the stock remains steady at INR5,000 during expiry. We take this strategy when we do not expect the market to move much within the expiry period. Short straddles are not just good strategies for options trading for beginners but experts as well.

Read Also: Best Intraday Trading Tips for Beginners

Strangles

The Strangles are also combination strategies. For this strategy, we pick two options, Call on the upside and Put on the downside, mostly equidistant from stock price.

This strategy also has the Long and Short versions. For the Long strangle strategy we buy two options, Call and Put as described earlier, when we expect the stock to move either way. These moves need to be bigger than what is required in long straddles.

Long Strangle
Long Strangle

We buy INR5,000 Put at INR70 and INR5100 Call at INR40 when the stock is at INR4,950. The profit is above INR5,210 and below INR4,980 because the cost price is INR70 + INR40 = INR110. Limited risk and unlimited profits in the event of a large move make this one of the best option trading strategies for beginners.

Similar is the Short Strangle. We employ this strategy when we expect the stock to move within a short range. We write the INR5100 Call at INR40 and also write the INR5,000 Put at INR70.

Short Strangle
Short Strangle

In Short Strangle, the maximum profit range should be from INR5,000 to INR5,100 and the maximum profit is INR110. Because when we wrote the options, we collected INR70 + INR40 = INR110 beforehand. Above INR5,210 and below INR4,890 during expiry, the loss is unlimited.

Wrapping Up

Option trading strategies for beginners described above are relatively easy and can be used after a bit of practice. A trader has to understand the market expectation and trend before employing these strategies. These Nifty and Bank Nifty trading strategies are good for beginners and can be applied on options.

Most of these strategies for options trading for beginners are risk adjusted and suitable for swing trading. But a trader must exit from the legs to control the losses if the market starts behaving the opposite way. There are number of strategies which require advanced understanding and thus, not suitable for beginners.

LEAVE A REPLY

Please enter your comment!
Please enter your name here