The great thing about options trading is that it is such a versatile financial instrument. It is possible to find option trading strategies that will suite most market situations. Whereas with stock trading you have to be right about the direction of the trade, options allow much more flexibility.
There are various options trading strategies which I will list below.
Vertical spreads:
This is a directional play. You can open either bearish or bullish positions. What is unique about this position is that both the maximum loss and the maximum profits are capped and depending on the strike combinations you choose you can alter the break-even point and the ratio between maximum profit and maximum loss to meet your risk-reward ratio.
This is a fairly “safe” position since losses are capped.
Calendar spreads:
This is an option strategy that involves buying and selling options of different expiration months. This strategy is NOT for beginners since this adds extra complexity. Calendar spreads are a relatively non-directional play since they come into profit within a certain price range. The maximum profit and loss are capped.
The key point about calendar spreads is that they are extremely sensitive to VOLATILITY, especially of the option expiring in the near month. Predicting the direction of VOLATILITY rather than PRICE is critical to profiting in this position.
Straddles / strangles:
These positions profit within a certain price range. When selling a straddle / strangle profit is made within a certain price range. Profits are capped and losses are unlimited. Due to the risk of unlimited losses, it is generally unwise to open these types of trades.
When BUYING straddles / strangles, profit is made if the options move OUTSIDE a certain price range. Profits are unlimited and losses are capped. This can be a decent strategy to use if you expect a large price movement but are unsure of the direction (for example earnings results). This position, like calendar spreads, is highly sensitive to VOLATILITY. Since this strategy is highly VEGA positive, the position profits if volatility increases. (Vega is one of the “options Greeks” which indicates the effect of volatility on the position).
Butterfly spreads, Condors and Iron Condors:
These three trades have the following in common – they profit if the price stays within a certain range, profits
and losses are capped and they benefit from DECREASES in volatility. These non-directional strategies are appropriate when you think the underlying asset will trade within a certain range. Another feature is that they can also be nicely ADJUSTED to respond to changes in market conditions.
The above is a very short summary. Options trading is a rather complex field, but if one invests some time it IS possible to learn to use effectively. Indeed options really are a key tool to complement your investing knowledge.
Options can be used as a speculative tool, however there are many strategies which can be used CONSERVATIVELY. Before starting out you should read some books about option trading strategies. However the knowledge you can gain for books is limited. It is best to learn directly from traders through an options trading course.