Dear Reader.
As traders, we want to be is nimble…
Between January and June 2022, the S&P 500 (SPX) shed over 20% of its value, and then from October to December that same year it recovered 15% during a short-term rally.
What’s clear is this…the market can change on us at any moment, and when it does, we simply want to recognize the changes in patterns and be nimble enough to choose the appropriate option strategy to profit.
There are a variety of recognizable and repeatable patterns found in the market, so I’d have you focus on one trading strategy at a time, and then continue building an arsenal of different option strategies over time in order to maximize your profit potential in our ever-changing market and economic conditions.
As you embark on your option trading journey I’d have you do two things:
The first thing is to recognize that market conditions change, which is where my AI-driven software comes into play – it identifies market patterns for us and presents trading opportunities. The second thing is to have a variety of trading strategies that can be employed to profit from when our market conditions change.
So, today I want to give you 5 trading strategies that can act as bread-and-butter trading strategies in a variety of market conditions – bullish and bearish trends and high or low implied volatility (IV).
5 Bread-and-Butter Trading Strategies to Enhance Success
At times the market is strong and bullish, so it makes sense to take advantage with long call options. Other times, the market is bearish, so long put options can be very lucrative.
You may find you wish to sell options for regular income or perhaps there you’ll want to take on high probability trades such as bullish or bearish vertical spreads.
So, let me introduce you to the basics of 5 bread and butter trading strategies using options.
I’ll cover all five strategies to get you started on building a variety of trading strategies to profit with throughout our changing market conditions.
The Long Call Option
Let’s start with the long call option. The long call option is a bullish strategy and is highly desirable due to leveraging ability. This simply means it’s cheaper to buy a call option than to purchase shares of the underlying security, and the call option can offer much greater returns on the investment versus shares as the price moves favorably.
A long call is simply a call option that is bought to open with an expectation that the underlying security will rise in value. Long call options are appealing because they can continue to gain in value as the security keeps rising. The stronger the movement in price, the more valuable long call options can become.
Then, once you expect the security is done running up, the call option is simply sold and closed out… then, on to the next one.
The Long Put Option
This second strategy I’m highlighting is fairly simple as well. A put option is bought to open when the trader expects the security to fall in value. It works just like a call option, however. After buying the put option, we simply want the option to increase in value, and after it has, the contract can be closed out by selling it.
It may seem odd at first, but just keep this one thing in mind and it’ll all become a little clearer for you when it comes to profiting with puts…
The value of the put contract becomes greater when the underlying security falls in value. The deeper the decline is in the underlying security, the greater the put option value can become. To maximize the value of the put, the security would need to fall to zero.
So. The benefit of buying put options is that it provides an easy way to profit from falling stock prices.
The Vertical Spread
The next strategy I’ll discuss is a vertical spread. I’ll start by saying that you can create both bullish and bearish trades with vertical spreads, and they’re actually fairly straight forward to construct as well.
To keep it simple, let’s suppose you bought a $100 call that expires on the third Friday of next month. Now, to turn your single call trade into a vertical, you will simply sell another strike price with the same expiration – the two options combined create a vertical spread.
And I mentioned you can create either bullish or bearish spread trades, so let me tell you how to keep it straight.
If you purchase the $100 call and you sell another call with a higher strike price, say $105, this creates a bullish trade. On the other hand, if you decided to sell a $95 call along with your long $100, your trade would be bearish because you sold a lower strike price. It’s as simple as that.
To determine where the stock’s price must move to obtain the maximum profit potential, just think about the strike price you’re selling. In the case where you sold the $105 call along with your $100 call, the maximum benefit occurs when the security trades above your higher strike – $105.
Conversely, if you had sold the $95 call along with your $100 call, the maximum benefit occurs below your $95 call option.
The example vertical spreads below will help you to visualize a vertical spread and to achieve the maximum profit potential.
Now that you’ve got an idea of how call vertical spreads are created, you’ll find that put verticals are just as easy because the same rules apply. Just replace the Call with Put in the examples above and you’ll have put verticals instead of calls.
Let’s talk about combining long calls with long puts next.
The Straddle Strategy
If you’re confident the security will rise higher or lower, but you’re not quite sure which direction it will go, then a Straddle strategy can put you in a situation where it won’t matter which direction the price moves, as long as it moves big in either direction.
This is where a straddle can be utilized to make the profit for you. So, let me first tell you how easy it is to construct a Straddle trade.
It’s simple – once you’ve decided which call strike price and expiration to buy, you can then buy the same put option contract, which creates the straddle trade.
That was the easy part. Now, let me give you some cautions about straddle trading.
First of all, since you have purchased both a call and put together, you’ve nearly doubled your investment.
So, with a bigger investment, a bigger movement in the underlying security is required. This simply means that when you buy a straddle the best profit outcome is had when the security makes a strong move… but luckily the move can occur in either direction.
My final strategy to talk about is the bullish short put strategy.
Short Puts
I’ve spoken above about the long call and long put option, which simply means the contract was purchased as an initial position.
So, when buying to open an option contract, the position is considered “long.” And, therefore, when the initial trade is a sell, it is considered a “short” position.
Traders often refer to long positions when they have purchased contracts, and short positions when they have sold contracts.
There are three things I’d like you to consider when selling put contracts, however.
First, as discussed earlier, when buying a put, you’ll have a bearish bias – you profit when the stock’s price falls. So, conversely, the opposite is true when selling puts – your bias is bullish – profits are made when the security rises above the sold strike price.
The second consideration is when selling puts you are in an obligation to buy shares of the security at the strike price. So, for example, if I sell a $40 put contract, I have an obligation to buy shares of stock at $40 per share, which would be a $4,000 stock investment.
In many cases you may not end up acquiring the shares of the stock, but at least be aware that the possibility exists.
The third consideration has to do with having enough cash in your brokerage account to buy shares of the stock if necessary – this is called a cash-secured put. Otherwise, a margin account is required, and if cash is not available to buy (cover) the shares, the position is considered to be “naked.”
In either case, selling puts can be great way to generate regular income to your portfolio.
These five trading strategies can act as the break and butter to your portfolio. Regardless of market trend or economic situation, having these strategies as part of your arsenal can make it possible to trade in any economic or market situation.
Don’t worry about being a pro with these strategies overnight. That’s what I’m here for…
So, your next step is to join me every Monday through Wednesday on Money Morning LIVE, which is the place that I talk a lot about market conditions, trading patterns and applying the appropriate strategy.
Until next time,
Tom Gentile
America’s #1 Pattern Trader
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