Leverage and the possibility of larger returns are provided by the trading strategies for beginners, but if utilized incorrectly, there is a substantial risk involved.
Some strategies are a good place to start for novice options traders because of their ease of use and minimal risk. These are the top 5 simple options trading strategies that novices should start with.
5 Trading Strategies for Beginners
Although options trading can be difficult and dangerous, novices can use the correct strategies to better use this financial tool. These are five beginner-friendly options trading strategies:
Buying Calls and Puts
Purchasing call or put options to speculate on the upward or downward movements of the underlying stock is the most fundamental approach to trading options. You can profit from buying calls if you predict that the stock will move above the strike price before expiration. With puts, you can profit if the stock drops below the strike price during your set period.
Purchasing calls or puts does not entail the greater risks associated with selling options because your loss is restricted to the premium paid. To make the biggest profits from purchasing, your directional forecast needs to be precise because options have time decay.
You can make money by writing (selling) covered calls against stocks you already own. You earn the premium by selling call options at a predetermined strike price, but you also commit to selling your shares if the options are exercised. In markets that are flat or trending downward, this strategy performs best.
A consistent premium income stream that can partially counteract stock declines is the primary advantage of covered calls.
Cash Secured Puts
Put selling enables you to obtain premium income at a lower price on stocks you want to own. You sell cash-secured puts on stocks about which you have a long-term bullish opinion below the current market price. You keep the premium in the event the puts expire worthless. On the other hand, you have to purchase the stock if the puts are exercised.
In essence, using this strategy, you can “buy low” on stocks you wish to own. If the premium is exercised, it also lowers your effective cost basis on the shares. While waiting patiently for the right entry point, cash-secured puts allow for the generation of returns.
Bull Call Spreads
By selling a call with a higher strike than the one you buy, call spreads enable you to pay a net lower premium. For instance, you could purchase a 50-strike call and sell a 55-strike call to offset the cost. If, prior to expiration, the stock moves up to the higher short call strike, profits are made.
The maximum gain and loss parameters are specified for these vertical call spreads. It limits your upside with a short-call strike. Your maximum loss is specified by the net position premium you paid. Compared to buying calls outright, call spreads require a substantially smaller initial investment and entail less risk of loss than naked call writing.
Bear Put Spreads
By selling a lower strike put against one you buy, put spreads function in the opposite way as call spreads, allowing you to pay less premium. To lower the net debit, for instance, you could purchase a 50-strike put and sell a 45-strike put. What separates the strike prices is the maximum gain.
With this defined risk strategy, one can profit from a bearish stock forecast down to the short put strike price. If the stock unexpectedly rises, the short put limits losses. Buying puts outright is more expensive than trading market declines with put spreads.
Frequently Asked Questions
What is the best strategy for beginners?
Due to its defined and controlled risk, buying calls and puts is the ideal beginning strategy. Additionally suitable for novices are covered calls and cash-secured puts. Initially, steer clear of complex multi-leg tactics.
What mistakes should beginners avoid?
Typical beginner mistakes include trading options on earnings reports, overleveraging accounts on trades, ignoring time decay effects, and not managing positions. Limit your use of small sizes and simple strategies.
Although they present special strategic advantages, options are not without risk. Experience managing defined risk trades is made possible for novice options traders by using the five simple strategies mentioned above. Further strategies can be scaled to match your increasing proficiency as you advance.
Beginners can stay safer while navigating the learning curve by sticking to sensible position sizing and avoiding naked options.