Option Strategies

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An option is a contract giving the buyer the right to buy or sell an underlying asset like stock at a fixed price on or before a certain expiration date. Remember this is a right and not obligation. There are basically two types of option contracts: Call options and Put options. A Call gives the buyer the right to buy the underlying asset, while a Put gives the buyer the right to sell the underlying asset.

The basic strategy for option trading is call and put. When you believe that a stock if going to be up, buy call option. But if you believe the price will go down, buy put option.

You can create advanced option strategy by combining the two basic option contract. For example you can create a new option strategy by buying one put option and selling another put option with different expiration date and strike price. Each strategies will have different characteristic, so you need to understand the profit and loss probability of a combination.

There are also option strategy that can generate income. This happens when you are selling an option contract at higher price and buy another option contract at lower price. For example you can sell a put option for $100 and buy another put option for $80, making $20 profit. The most popular income option strategy are Iron Condor. It is constructed by combining Bull Put Spread and Bear Call Spread. Bull Put Spread is constructed by selling an in-the-money (ITM) put option (higher price) and buying an out-of-the-money (OTM) put option (lower price) on the same stock with the same expiration date. While Bear Call Spread is constructed by selling an in-the-money (ITM) call option (higher price) and buying an out-of-the-money (OTM) call option (lower price) on the same stock with the same expiration date. With Iron Condors you don’t have to guess the direction of a stock. This strategy is mostly used when we have a neutral outlook of a stock.

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