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Newcomers to the world of options trading often find the wide variety of possible option trading strategies confusing. To really comprehend where all of the possible types of option trading strategies come from, we first need to get a good grasp on the mechanics of options, and then take the time to understand the positions that a trader can plan strategy from.
Options trading strategies are all developed from the concepts that make options work as investments. Whether buying or selling an option, the trader is making a prediction as to what sort of value change the asset that underlies the option will make during the coming weeks and months. Traders study trends and markets, and then speculate as to what will happen during the period of the option, and buy or sell options in that asset based on that prediction in the hope of making a profit.
If the prediction is that the price of the asset will rise, then traders use a call. Option trading strategies using calls are some of the most common trades, and the long call is in fact what most people think of when they consider options trading. The trader is predicting that the value of the asset will rise during the period the option is open, and purchases the right to buy the asset at a set strike price.
If the prediction is that the price of the asset will decline during the coming weeks, then a trader would use a put strategy. In this case, the option is to sell to the asset at the strike price rather than sell. As with the call, the option can either be exercised or allowed to expire.
Of course, there are both buyers and sellers in options, and just as there are option trading strategies for buyers, there are also option trading strategies for sellers.. A buyer is said to have a long position, while a seller has a short position. In a short call, an option seller is predicting that the buyer is wrong and the price will go down, allowing the seller to profit. In a short put, the seller is predicting that the price will go up, contrary to what the buyer is predicting. The seller profits from all of the premiums paid on options that are allowed to expire.
These are some of the simple option trading strategies; they can be far more complicated.
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