Trading options is a great way to make money, but it can be an intimidating process to start as a beginner. Since the main goal when starting a new financial endeavor is make more money than you lose, a lot of people are hesitant to take any risks. However, big risks are not always necessary to increase your gains. It is possible to take a more conservative approach and still come out ahead. Below are a few low-risk strategies to help you learn option trading basics.
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Hedging is akin to buying an insurance policy. It reasonably lowers the risk of loss by investing in a safety net. In the case of insurance, the safety net is the cost of the premium to ensure that you will be compensated for your valuables if something were to happen to them. For options, the safety net is investing in negatively-correlated investments, meaning if the value of one decreases, the value of the other should increase. It minimizes the risk by allowing you to bet on both sides, so you’ll always be favorable in some aspect of your investing.
Spreading is the strategy of buying two or more of the same option on the same basic security, but with different expiration dates or strike prices. Using at least two option positions is desirable because it limits the risk by allowing the trader to make a spread with basically any market outcome. The cost to spread is low since one option is usually sold off in order to purchase a newer one.
A synthetic is a specific type of spread. It is a way of creating a position that behaves and looks like one asset, but – in reality – is actually comprised from completely different assets. The reason this is done is because one form might be more effective than another.
This is considered one of the safest ways to sell an option and is even used frequently for IRAs. The covered call strategy involves you either owning one hundred shares of stock or purchasing it. You would then sell a call option against those shares. The premium you collect for selling the call is what reduces the risk in this scenario.
The worst-case scenario is that the stock performs better that you expected and you must then sell the stock. The best-case scenario is that the stock under-performs, meaning you get to retain it, all while collecting the premium for the call. Once the option expires, you’re then free to perform another covered call with the stock.
All trading comes with inherent risks. Many new traders fear of market crashes, but by using one or a combination of these strategies, the risk can be minimized. Remember that if a potential deal appears too good to be true, it probably is, so apply due diligence when researching your deals. Make sure you understand the risks you’re taking before agreeing to any courses of action.