Options can be among the best financial tools for enhancing and protecting one's portfolio or even speculating about current events. Despite their relative complexity, options play a crucial role in modern investing by offering a range of strategic possibilities for portfolio management, risk mitigation and profit maximization.
Against the backdrop of heightened investor anticipation and broad macroeconomic uncertainty, the market environment of 2024 was ripe for using options to manage risk, generate income, speculate on price movements or enhance portfolio returns. According to the Options Clearing Corporation (OCC), the total contract volume for 2024 was 12,284,357,036, approximately 10.6% higher than 2023's total contract volume.
Popular Option Trading Strategies
For individuals engaging in options trading, the strategy chosen is predicated on one's market outlook or the opportunity at hand. The following are some popular strategies options traders use depending on whether they have a bullish market outlook, a bearish market outlook or an anticipatory market volatility outlook.
Bullish Market Outlook
A Bull Call Spread is a bullish option strategy designed to profit from a rise in the underlying asset’s price within a specific range. This involves buying a call option at a lower strike price and selling another call option at a higher strike price, both expiring on the same date.
Outcome: The strategy limits potential gains and losses, making it suitable for investors who expect a moderate price increase in the underlying asset and seek to reduce upfront costs compared to buying a single-call option outright.
A Bull Put Spread is also a bullish option strategy; however, its objective is to generate income while minimizing risk. The strategy involves selling a put option with a higher strike and simultaneously purchasing a put option with a lower strike price; both maintain exposure to the same underlying asset and expiration date.
Outcome: The highest profit is achieved if the underlying asset’s price is at or above the higher strike at expiration. Conversely, the maximum loss is limited to the difference between the strike prices minus the net premium.
Bearish Market Outlook
A Bear Put Spread is an options strategy designed to capitalize on a decline in the underlying asset. The strategy involves purchasing a put option at a higher strike price and simultaneously selling a put option at a lower strike price, both with the same expiration date.
Outcome: The highest profit occurs when the underlying asset's price falls to or below the lower strike price. Conversely, the maximum loss is limited to the net premium paid for the spread.
A Bear Call Spread involves selling a call option at a lower strike price and buying another call option at a higher strike price, both with the same expiration date.
Outcome: The maximum profit is limited to the net premium received from selling the lower strike call and purchasing the call option with the higher strike price. Conversely, the potential loss is limited to the underlying asset's price rising above the long call’s strike price.
Volatile Market Outlook
A Long Straddle option strategy involves simultaneously buying a call option and a put option on the same underlying asset, with the same strike and expiration date. This strategy is advantageous when significant volatility that will impact the underlying asset is expected, but there is uncertainty as to how the asset will react.
Outcome: If the underlying asset's price rises materially, the call option's value increases. Conversely, if the asset's price falls substantially, the put option's value increases. The profit potential from this strategy can be unlimited, given that the asset price moves far enough beyond the strike to surpass the cost of the premiums. However, the maximum loss is limited to the combined premiums paid for both options.
A Long Strangle option strategy also requires buying a call option and a put option on the same underlying asset; however, the options will have the same expiration date but different strike prices. Typically, the call option will have a higher strike price, and the put option will have a lower strike price.
Outcome: This strategy is advantageous when the underlying asset's price will move significantly beyond the strike price, leading one option to increase in value and the other to diminish, with the loss being limited to the premium paid.
Neutral Market Outlook
An Iron Condor option strategy involves buying two puts (one long and one short) and two calls (one long and one short) with four strike prices, all with the same expiration date. This strategy profits the most when the underlying asset does not move much, although the strategy can be modified to suit both a bullish or bearish outlook. This strategy has limited upside and downside risk.
Outcome: The iron condor strategy earns the trader the maximum profit when the underlying asset closes between the middle strike prices at expiration. As such, the goal is to profit from low volatility in the underlying asset.
Navigating An Evolving Investment Landscape With Options
In 2024, the investment landscape was impacted by anticipated events, such as the gradual lowering of interest rates, as well as unexpected occurrences, such as Japan's Yen carry trade that briefly crashed the global markets, not to mention the uncertainty and surprises arising from the U.S. Presidential Election. Though each event differed in its impetus and impact, traders who utilized options could implement strategies that limited their losses or enabled them to capitalize on the moment. For traders looking to amplify their investment conviction, options allow them to leverage their market views with potentially high returns, often with limited capital and defined risk.
Taking Action
Having the right knowledge and tools is crucial to success in options trading. Cboe's The Options Institute helps both beginners and sophisticated traders familiarize themselves with foundational knowledge on options or learn new developments taking place within the investment derivatives landscape. The Options Institute provides comprehensive courses and tools, equipping investors with the knowledge needed to navigate the complexities of options trading effectively. It is important to remember that responsible options trading is based on defining an investment objective and using analysis and informed decision-making to determine the most appropriate trading strategy. Understanding how options work and the associated risks, just like any other financial asset, is paramount.
Cboe, the inventor of listed options trading and operator of the largest U.S. options exchange, is focused on innovation and making markets more accessible for retail traders. In 2006, Cboe launched VIX options, the first exchange-traded option that gave investors the ability to trade on expected market volatility. VIX options are now available for trading during Cboe's Global Trading Hours, making the product more accessible to retail traders.
Options can be among the best financial tools for enhancing and protecting one's portfolio or even speculating about current events. For investors looking to navigate capital markets deftly and decisively, options offer the potential for targeted investing, passive income, better risk mitigation and income generation.
Featured photo by Nicholas Cappello on Unsplash.
This post contains sponsored content. This content is for informational purposes only and is not intended to be investing advice.
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