Options trading is a complex but highly lucrative form of investment. Trading options in Australia can benefit those looking to diversify their portfolios, hedge risk, or find new ways to make money with their capital. This guide will look at Australia’s most popular listed options trading strategies and how they can increase returns while reducing losses. We will consider the risks associated with each strategy and discuss potential management methods.
Long call strategy
The long call strategy involves buying a call option on a stock that one believes will rise in value. This strategy is most suitable for those who are confident about the performance of a particular stock and want to capitalise on its expected growth without having to purchase shares outright.
When setting up this strategy, the investor pays a premium which gives them the right (but not the obligation) to purchase a fixed number of shares at an agreed price (or strike price) until a specific date. If the share price goes above the strike price before expiry, they can purchase these shares at a lower rate and pocket any gains resulting from changes in market prices.
The main advantages of using a long call strategy include:
- Leveraging small amounts of capital into significant returns.
- Limiting losses if the stock does not perform as expected.
- Avoiding the restrictions associated with traditional share trading.
However, this strategy also carries certain risks, such as time decay (or theta) – where the option’s value decreases as its expiry date approaches.
Short put strategy
The short put strategy is an excellent way for investors to generate income by selling puts on stocks they believe will stay steady or increase in value over time. This strategy requires an investor to sell a put option on a stock they are willing to purchase at the agreed strike price or already own shares. The investor would then receive an upfront premium compensating them for taking on the risk of buying shares if necessary.
To successfully execute this strategy, it is crucial to be diligent in monitoring the market and understand the stock’s price changes. If you trade with Saxo, you can have a broker to help you with strategies such as this.
The benefits of this strategy include:
- The potential for immediate returns.
- Less capital outlay than traditional share trading.
- Capitalising on any gains if the stock does not fall below the strike price before expiration.
However, there are also risks associated with this method, including time decay (or theta), causing losses if not managed properly.
The straddle strategy involves buying a call and put option at the same strike price and expiry date for the same underlying asset. Traders use this strategy to benefit from volatility in either direction as long as the stock moves significantly before expiration. The cost of executing this strategy can be high, but the potential for a significant return makes it attractive to some investors.
When setting up a straddle position, traders must consider both time decay and Vega (the option’s sensitivity to changes in implied volatility). Losses may result from time decay if the price does not move significantly before expiration. If implied volatility increases without corresponding price movements, losses will also be incurred due to the higher vega value.
To implement the risk reversal strategy, you must simultaneously purchase an out-of-the-money (OTM) call option and sell an OTM put option on the same underlying asset. Traders use this method to construct a synthetic long position in the stock while reducing their overall cost by receiving an upfront premium from the seller of the put option. If used correctly, this strategy can yield significant returns, allowing traders to benefit from both upside and downside movements in the market.
For example, if a trader believes that a particular stock is likely to increase in value over time but is concerned about short-term volatility, they could purchase an OTM call option and sell an OTM put option at the same strike price. If the stock increases significantly before expiration, they will have made profits due to both options expiring in the money.
The collar strategy is a popular options trading strategy used by investors who want to protect their existing stock positions from downside risk while benefiting from any upside price movement. It involves buying an OTM put option and selling an OTM call option on the same underlying asset, with both options having the same expiration date. By purchasing the put and selling the call, investors are protected against significant losses should the stock’s value fall significantly before expiry while allowing them to capitalise on any potential upside movements in the market.
The main benefits of using this method include protection against adverse price movements and limited capital outlay due to receiving an upfront premium when selling the call option. However, certain risks are associated with this strategy, such as time decay (or theta), leading to losses if not managed properly.