The 3 Best Options Strategies for Beginners

Mastering options trading can seem like a daunting task for newcomers, but it doesn’t have to be. By focusing on three key strategies, beginners can get a solid foundation in options trading. Here’s a breakdown of the three most effective options strategies for beginners, explained in detail to help you start trading confidently and intelligently.

1. Covered Call

Definition:
A covered call is a strategy where you own the underlying asset (like stocks) and sell call options on that asset. This strategy is best for investors who believe that the price of the underlying asset will remain relatively stable or rise slightly.

How It Works:
You buy 100 shares of a stock and sell one call option contract on that stock. If the stock price remains below the strike price of the sold call option, you keep the premium from selling the option and still own the stock. If the stock price rises above the strike price, you may have to sell the stock at the strike price but keep the premium as additional profit.

Example:
Suppose you own 100 shares of XYZ Corp. trading at $50 per share. You sell a call option with a strike price of $55 for a premium of $2 per share.

• If XYZ stays below $55, you keep the $200 premium (100 shares × $2).
• If XYZ rises above $55, you sell your shares at $55 and keep the $200 premium.

Advantages:

• Generates income through premiums.
• Reduces overall risk as the premium received provides a buffer against declines.

Disadvantages:

• Limits profit potential as you have to sell the stock at the strike price.
• Requires owning the underlying stock, which might not always be feasible.

2. Cash-Secured Put

Definition:
A cash-secured put involves selling a put option while having enough cash on hand to purchase the underlying asset if the option is exercised. This strategy is used when you’re willing to buy the stock but want to earn income from the option premium.

How It Works:
You sell a put option and set aside enough cash to buy the underlying asset at the strike price. If the stock price is above the strike price at expiration, you keep the premium. If the stock price falls below the strike price, you must buy the stock at the strike price, but you keep the premium, reducing your effective purchase price.

Example:
Suppose you’re interested in buying 100 shares of ABC Inc. at $40. You sell a put option with a strike price of $40 and a premium of $3 per share.

• If ABC stays above $40, you keep the $300 premium (100 shares × $3).
• If ABC falls below $40, you buy the stock at $40 but effectively pay $37 per share due to the $3 premium.

Advantages:

• Earns income from the premium.
• Allows you to buy stocks at a lower effective price if the option is exercised.

Disadvantages:

• Requires having enough cash to buy the underlying stock.
• Potentially buying a stock at a higher price than its current market value if the stock declines significantly.

3. Long Call

Definition:
A long call strategy involves buying a call option with the expectation that the price of the underlying asset will rise significantly. This strategy provides the potential for unlimited profits with a limited risk.

How It Works:
You purchase a call option with a specific strike price and expiration date. If the stock price rises above the strike price, you can buy the stock at the strike price and sell it at the higher market price, making a profit.

Example:
Suppose you buy a call option for DEF Ltd. with a strike price of $30 and a premium of $2. If DEF’s stock price rises to $40, you can exercise your option to buy the stock at $30 and sell it at $40, making a profit of $8 per share ($10 gain minus $2 premium).

Advantages:

• Unlimited profit potential.
• Risk is limited to the premium paid for the option.

Disadvantages:

• The entire premium can be lost if the stock price does not rise above the strike price.
• Time decay affects the value of the option as the expiration date approaches.

Conclusion

Each of these strategies—Covered Call, Cash-Secured Put, and Long Call—offers unique advantages and risks suited to different market conditions and investor goals. By starting with these fundamental strategies, beginners can build a solid foundation in options trading. Practice, research, and experience will further refine your strategies and help you become more adept at navigating the options market.