In the world of Options trading, there are a plethora of strategies to choose from.
And if you’re just starting out, it can be very confusing knowing which Options strategy to use.
And what’s even more confusing is knowing exactly when to use each of these strategies.
If you use a bullish Options strategy and the market goes down, you lose money.
And if you use a bearish Options strategy and the market goes up, you lose money.
So how do you know exactly which Option trading strategy to use?
And how do you know exactly when to use each of the strategies?
If you’re new to trading Options, then this ultimate guide will cover everything you need to know about the different Options strategies…
And you will know exactly which ones to focus on and when to use them.
The 3 Option Trading Strategies Categories
When it comes to Options strategies, there are three main categories:
- Bullish Options Strategies – These are strategies that make you money when the market goes up.
- Bearish Options Strategies – These are the strategies that make you money when the market goes down.
- Neutral Options Strategies – These are the strategies that make you money when the market stays in a certain range.
And for each of these categories, they can be further broken down into two types:
- Debit strategies – This is where you pay a debit for the trade. The win rate for debit strategies is usually 50% or less.
- Credit strategies – This is where you received a credit for the trade and is also known as premium-selling strategies. The win rate for credit strategies is usually more than 50%.
Bullish Options Strategies (Debit)
For bullish debit Options strategies, there are three main strategies:
- Long Call
- Bull Call Spread (aka Debit Vertical Spread)
- Call Diagonal Spread
The Long Call
The Long Call Option is the simplest bullish strategy.
You either buy an Out-of-The-Money (OTM) Call, At-The-Money (ATM) Call, or In-The-Money (ITM) Call.
The most popular one among beginners is to buy an OTM Call because it’s the cheapest with the highest risk-to-reward ratio.
However, it’s also where most people lose money because it has very little chance of working out.
That’s because an OTM Call only has extrinsic value, and it will decay over time.
So even if the market goes up, but it doesn’t go up quickly enough, you could still end up losing money.
The only viable way to trade the Long Call is if you buy a deep ITM Call with a high DTE where there’s very little extrinsic value.
This is what’s called a LEAPS Option and is considered a stock replacement strategy.
However, it can be rather capital-intensive.
The Bull Call Spread
The Bull Call Spread is a Long Call plus an OTM Short Call.
This is a more cost-efficient way to trade a bullish view compared to the Long Call.
The difference is that now there’s a capped max profit.
So even if the market shoots to the moon, your profit can’t exceed the max profit of the trade.
This is also a popular strategy among beginners to trade a bullish bias in the market.
And because it’s a debit spread, the max you can lose is what you paid for the spread.
Hence, it’s considered a very safe strategy for beginners to get started in trading Options.
The Call Diagonal Spread
The Call Diagonal Spread is similar to the Bull Call Spread, except that the Long Call has a longer DTE (days to expiration) than the Short Call.
The idea here is that if the market goes up, the Short Call can be rolled out and up again to increase the max profit.
Basically, it’s treated very similarly to a Covered Call.
And it can be rolled until it becomes a Bull Call Spread where the Short Call would then have the same DTE as the Long Call.
This is usually used if you have a very strong bullish bias on the market.
Bullish Options Strategies (Credit)
For bullish credit Options strategies, there are five main strategies:
- Short Put
- Bull Put Spread
- Super Bull
- Put Ratio Spread
- Put Broken-Wing Butterfly (BWB)
The Short Put
The Short Put is the simplest bullish credit strategy.
This is where you can sell a Put Option and receive a credit upfront.
And as long as the market is above the Short Put strike price at expiration, you will get to realize the full profit of the credit.
But if it goes below your strike price, then this is where you could get an early assignment and become Long 100 shares.
Hence, it’s important to know how to trade the Short Put properly to avoid huge losses.
The Bull Put Spread
The Bull Put Spread is also referred to as the bullish Credit Spread.
It’s a Short Put but with a further OTM Long Put to cap the max loss.
Unlike the Short Put, if the market goes to zero, you can’t lose more than the risk you’ve allocated to the trade.
Credit Spreads are by far the most popular strategy among beginners because it’s relatively safer.
And it’s ideal for small accounts!
The Super Bull
The Super Bull is a combination of two strategies:
- Short Put
- Bull Call Spread
Basically, the credit received from selling the Short Put is used to finance the purchase of the Bull Call Spread.
This way if the market goes up, it will be more profitable than if you just traded the Short Put.
This strategy is one of the least commonly used but can be good in certain market conditions.
Put Ratio Spread
The Put Ratio Spread consists of two strategies as well:
- Short Put
- Bear Put Spread (Debit Spread)
While the Super Bull uses the Short Put to finance the Bull Call Spread, the Put Ratio Spread uses the Short Put to finance the Bear Put Spread.
So you have a bullish strategy (Short Put) combined with a bearish strategy (Bear Put Spread).
This is one of my favorite strategies to use because it is omnidirectional.
That means it can make money if the market goes up, stays sideways, and can potentially make more if the market goes down.
And it has a huge profit zone.
However, the risk is still to the downside.
Hence, I categorized this as a bullish Options strategy.
Put Broken-Wing Butterfly (BWB)
Finally, we have the Put BWB, which is essentially the defined-risk version of the Put Ratio Spread.
That means you add a Long Put below the Put Ratio Spread.
This is to cap the max loss on the trade.
However, with this Long Call, the dynamics of the trade would be slightly different than the Put Ratio Spread.
And the profit zone will be much smaller compared to the Put Ratio Spread.
Bearish Options Strategies (Debit)
For bearish debit Options strategies, there are also three main strategies:
- Long Put
- Bear Put Spread (aka Debit Vertical Spread)
- Put Diagonal Spread
The Long Put
The Long Put is commonly used as a form of “protection” for a Long stock portfolio.
This way if the market crashes, it will be hedged by this Long Put.
However, this can be a rather expensive way to protect a portfolio because if the market keeps going up, then this Long Put will lose a lot of its value over time.
Nevertheless, if you fear a market crash, then a Long Put can be a great way to hedge your stock positions, or as a way to speculate to the downside.
The Bear Put Spread
The Bear Put Spread is a more cost-efficient way to trade a bearish view.
However, the max loss is capped.
It is the opposite of the Bull Call Spread.
And if you recall, it’s part of the Put Ratio Spread.
The great thing about the Bear Put Spread is that if it’s traded on the Index ETFs (SPY, QQQ, IWM), it has a Positive Expectancy by default.
That’s because of the Put skew.
So over time, this strategy can be very profitable when used at the right time.
The Put Diagonal Spread
The Put Diagonal Spread is similar to the Bear Put Spread, except that the Long Put has a longer DTE than the Short Put.
Similar to the Call Diagonal Spread, the idea here is to roll the Short Put out and down if the market continues going down.
This way the max profit can be increased with each roll.
The Put Diagonal Spread can also be a great way to hedge against a Long stock portfolio because it’s more cost-efficient compared to the Long Put.
Bearish Options Strategies (Credit)
For bearish credit Options strategies, there are five main strategies:
- Short Call
- Bear Call Spread
- Super Bear
- Call Ratio Spread
- Call Broken-Wing Butterfly (BWB)
The Short Call
The Short Call is basically to sell a Call Option.
If you don’t have 100 shares to sell the Call Option against, then it’s a Naked Call.
If you have 100 shares to sell the Call Option against, then it’s a Covered Call.
I don’t recommend trading the Naked Call just by itself because you can lose lots of money if you don’t know what you’re doing.
The market in general has a positive drift, which means the market wants to go higher over time.
And if you have a Naked Call, then your loss can be unlimited because there’s no limit to how high a stock can go.
A better and more common use of the Short Call is the Covered Call.
The Bear Call Spread
The Bear Call Spread (aka bearish Credit Spread) is the defined-risk version of a Short Call.
Basically, you buy a further OTM Call to cap your max loss.
This way, even if the market continues going up, you can only lose what you’ve risked at the start.
And if you trade it the right way and manage your risk well, this can be a very profitable strategy.
Hence, this is also a very popular strategy among beginners and those with small accounts.
The Super Bear
The Super Bear is the opposite of the Super Bull.
It consists of two strategies:
- Short Call
- Bear Put Spread
The credit received from the Short Call is used to finance the purchase of the Bear Put Spread.
This way if the market goes down, you’d be able to make more than just a Short Call alone.
Because of the Naked Call element in this strategy, it can be a risky strategy if the market rallies.
The Call Ratio Spread
The Call Ratio Spread is the opposite of the Put Ratio Spread.
It consists of two strategies:
- Short Call
- Bull Call Spread
The credit received from the Short Call is used to finance the purchase of the Bull Call Spread.
So the max profit zone is where the Short Call strikes are.
This is also an omnidirectional strategy where it can be profitable in all directions.
But the risk still lies to the upside.
And it may not be as effective as the Put Ratio Spread because most equities tend to have Put skew.
That means the Call Ratio Spread wouldn’t have the same max profit zone as the Put Ratio Spread.
However, if it’s done on a stock with a Call skew, then it could be more effective than the Put Ratio Spread.
The Call Broken-Wing Butterfly (BWB)
The Call BWB is the defined-risk version of the Call Ratio Spread.
You just have to purchase a further OTM Call above the Call Ratio Spread and the max risk would be capped.
This would make the trade safer and more beginner-friendly.
However, the tradeoff would be a much smaller profit zone.
Neutral Options Strategies (Debit)
For neutral debit Options strategies, there are three main strategies:
- Long Straddle
- Calendar Spread
- Iron Fly / Butterfly
The Long Straddle
The Long Straddle is an ATM Long Call and Long Put combined.
This is to speculate on a big move in either direction.
While this sounds like a great way to trade, it’s actually hard to be profitable.
That’s because this is the most expensive strategy to trade and has the max amount of extrinsic value to overcome.
Each day you’re holding on to the straddle, its value is decaying.
In order for this strategy to be profitable, the market has to make a big move in either direction in a short time.
And even if you get the move in the direction you want, but it got there too slowly, you will still lose money.
So only put on this strategy if you think the underlying stock could have a big move in either direction.
The Calendar Spread
The Calendar Spread is a strategy that seeks to profit if the market doesn’t move much.
It’s the combination of a longer DTE and a shorter DTE at the same strike price.
They can both be either Call or Put Options.
The idea of this strategy is to take advantage of the difference in volatility between the longer DTE and the shorter DTE.
Generally, we want the shorter DTE to have much higher volatility than the longer DTE.
However, this is a rather low-probability strategy.
The Iron Fly / Butterfly
The Iron Fly / Butterfly is a defined-risk strategy where you anticipate the market to stay in a tight range.
It has a high risk-to-reward ratio where you could risk $1 to make $2 or more.
However, it has a low win rate.
And with a low win rate, you can have a long losing streak.
So it can be a very difficult strategy to consistently put on all the time.
It’s also used as a roll where you roll an Iron Condor into an Iron Fly.
Neutral Options Strategies (Credit)
For neutral credit Options strategies, there are also three main strategies:
The Iron Condor
The Iron Condor is a neutral strategy that seeks to profit if the market stays within a certain range.
It is the combination of two credit spreads:
- Bear Call Spread
- Bull Put Spread
The Iron Condor is also as popular as the Credit Spreads because it’s a defined-risk strategy with a high win rate.
Hence, it’s considered a safe strategy for beginners to use and the best part about the Iron Condor is that you don’t have to have a bullish or bearish view to trade it.
If you’re not sure where the market is going, then trade the Iron Condor!
The Jade Lizard
The Jade Lizard is very similar to the Iron Condor.
However, instead of a Bull Put Spread on the Put side, it’s just a Short Put.
So this has gone from a defined-risk strategy to a partially undefined-risk strategy.
With the Jade Lizard, you will have a higher win rate than the Iron Condor.
And if you construct it properly, there can be no risk to the upside.
So even if the market rallies past the Short Call Spread.
So if you have a neutral-to-bullish view of the market, you’d want to put on the Jade Lizard.
The Short Strangle
The Short Strangle is essentially the fully undefined-risk version of the Iron Condor.
It consists of an OTM Short Put and an OTM Short Call.
While this can be rather scary and daunting for many traders because theoretically there is an unlimited risk…
In actual trading, that is very unlikely to happen.
In fact, the Short Strangle is one of the bread-and-butter strategies that generate a consistent income for me.
The key is to manage your risk well when trading this strategy.
If you’re able to manage your risk well, then the Short Strangle can be a very profitable strategy for you too.
How To Select The Right Options Strategies For You
As you can probably already tell, there is a plethora of Option strategies to choose from.
And what I’ve shared isn’t close to the exhaustive list of Option strategies that are available.
So far in this post, I’ve covered a total of 22 Option strategies.
This is far too many strategies to be focusing on, even for a professional trader.
What we want to do is whittle down to just one or two strategies for each of the categories to focus on.
So which strategies should you focus on, especially if you’re just starting out?
If you’re just starting out, then I’d suggest starting with just these three Option Strategies:
- Bull Put Spread
- Iron Condor
- Bear Call Spread
You have one for each category.
And if you’re slightly more advanced and have a larger account, then you can additionally use these two strategies:
- Short Put
- Short Strangle
These five strategies in total are more than enough for you to make a consistent income if you trade it the right way.
When To Put On Each Strategy?
So now that we know which strategies to focus on, how to know exactly when to put on each of these strategies?
For this, we will use the Stochastic Oscillator to help us.
The Stochastic Oscillator helps identify the three different market conditions:
- When the market is oversold.
- When the market is overbought.
- When the market is neutral.
So when the Stochastic Oscillator shows an oversold reading, only look for opportunities to place bullish Options strategies.
And when the Stochastic Oscillator shows an overbought reading, only look for opportunities to place bearish Options strategies.
Finally, if the Stochastic Oscillator is neither showing an oversold nor an overbought reading, then only look for opportunities to place neutral Options strategies.
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