Buying Calls (Long Calls)

Trading options offers certain advantages for individuals seeking to make directional bets in the market. If you anticipate a rise in the price of an asset, purchasing a call option allows you to do so with less capital than buying the asset itself. In the event that the price takes an unexpected downturn, your losses are confined to the premium paid for the options, providing a capped risk scenario. This approach may be particularly favored by traders who:

• Are "bullish" or optimistic about a specific stock, exchange-traded fund (ETF), or index fund and wish to mitigate risk? Want to employ leverage to capitalize on upward price movements? Options serve as leveraged instruments, enabling traders to magnify potential upside benefits using smaller amounts compared to what would be needed when trading the underlying asset directly. For instance, instead of committing $10,000 to purchase 100 shares of a $100 stock, one could potentially invest $2,000 in a call contract with a strike price set 10% higher than the current market price.

Buying Puts (Long Puts)

If a call option grants the holder the right to buy the underlying asset at a predetermined price before the contract expires, a put option provides the holder with the right to sell the underlying asset at a specified price. This strategy is often favored by traders who:

• - Hold a bearish view on a specific stock, ETF, or index but seek to assume less risk compared to employing a short-selling strategy.
• * Want to utilize leverage to take advantage of falling prices

A put option operates in the exact opposite manner compared to a call option, as its value increases when the price of the underlying asset decreases. While short-selling also enables a trader to benefit from declining prices, the risk associated with a short position is unlimited because there is theoretically no cap on how high a price can rise. In contrast, with a put option, if the underlying asset ends up trading higher than the option's strike price, the option will merely expire without value. This characteristic establishes a predetermined and limited risk for the holder of the put option.

Risk/Reward

The trader's potential loss from a long call is limited to the premium paid. Potential profit is unlimited because the option payoff will increase along with the underlying asset price until expiration, and there is theoretically no limit to how high it can go.

Covered Calls

Unlike the long call or long put, a covered call is a strategy that is overlaid onto an existing long position in the underlying asset. It is essentially an upside call that is sold in an amount that would cover that existing position size. In this way, the covered call writer collects the option premium as income, but also limits the upside potential of the underlying position. This is a preferred position for traders who:

• * Expect no change or a slight increase in the underlying's price, collecting the full option premium
• * Are willing to limit upside potential in exchange for some downside protection

A covered call strategy involves buying 100 shares of the underlying asset and selling a call option against those shares. When the trader sells the call, the option's premium is collected, thus lowering the cost basis on the shares and providing some downside protection. In return, by selling the option, the trader is agreeing to sell shares of the underlying at the option's strike price, thereby capping the trader's upside potential.

Protective Puts

A protective put involves buying a downside put in an amount to cover an existing position in the underlying asset. In effect, this strategy puts a lower floor below which you cannot lose more. Of course, you will have to pay for the option's premium. In this way, it acts as a sort of insurance policy against losses. This is a preferred strategy for traders who own the underlying asset and want downside protection.

Thus, a protective put is a long put, like the strategy we discussed above; however, the goal, as the name implies, is downside protection versus attempting to profit from a downside move. If a trader owns shares with a bullish sentiment in the long run but wants to protect against a decline in the short run, they may purchase a protective put.

If the price of the underlying increases and is above the put's strike price at maturity, the option expires worthless and the trader loses the premium but still has the benefit of the increased underlying price. On the other hand, if the underlying price decreases, the trader’s portfolio position loses value, but this loss is largely covered by the gain from the put option position. Hence, the position can effectively be thought of as an insurance strategy.

Long Straddles

Buying a straddle lets you capitalize on future volatility but without having to take a bet whether the move will be to the upside or downside—either direction will profit.

Here, an investor buys both a call option and a put option at the same strike price and expiration on the same underlying. Because it involves purchasing two at-the-money options, it is more expensive than some other strategies.