Best options strategies and tips

Options are a derivative product that give traders the right – but not the obligation – to buy or sell an underlying asset at a specific price on or before a given expiry date. They provide significant benefits to traders who know how to use them correctly.

Top 10 options trading strategies

The best options trading strategy for you will very much depend on why you are trading options – for example, a strategy for hedging will vary from one that is purely speculative. This makes it important to understand the benefits that each strategy provides.

Ten of the most popular options strategies are:

1. Short put option
2. Long put option
3. Short call option
4. Long call option
5. Short put vertical spread
6. Long put vertical spread
7. Short call vertical spread
8. Long call vertical spread
9. Covered call
10. Covered put

Short put option

A short put is a neutral to bullish strategy that involves selling a put option at a strike price at or below the underlying’s current market price. Short puts also go by other names, like bull put, naked put, or uncovered put.

Like other short premium options strategies, short put sellers benefit from time decay, which can decrease the option’s value, allowing you to buy to close at a lower price for a potential profit.

The max profit for a naked put is the initial credit you receive. The max loss is the total credit received minus the strike price x 100, because the underlying’s price can only drop to $0. You can also profit if the short put is closed or covered before expiration for a debit less than the total credit received.

If the short put expires worthless, you achieve max profit. However, you can also incur losses if the short put is closed before expiration for a debit more than the total credit received.

Long put option

Buying a put option gives you the right, not the obligation, to sell 100 shares of the underlying asset at the strike price on or before the expiration date. The put option’s value will increase as the price of the underlying drops closer to the put option’s strike price or falls below the strike price. That makes it a bearish strategy. On the other hand, the put option’s value can decrease when the underlying’s price rises or stays the same.

Out-of-the-money (OTM) puts are usually cheaper than in-the-money (ITM) puts because they only have extrinsic value. ITM puts have intrinsic and may have extrinsic value, which
makes them more expensive.

You can profit if you sell to close the long put for a credit greater than the total debit you paid. You get maximum profit if the underlying asset drops to $0. But you can see losses if you close the long put for a credit less than the total debit you paid. If the long put expires OTM, you will lose the debit you paid entirely.

If a long put expires ITM by $0.01 or more, each long put will auto-exercise and convert to 100 short shares per contract, resulting in short stock risk with unlimited potential loss. If the long put was used as a protective strategy for 100 long shares, your long shares will be sold at the strike, and you’ll no longer own the underlying.

Short call option

A short call option is a neutral to bearish strategy that involves selling a call option at a strike price at or above the underlying’s current market price. Short calls go by other names, like bear call, naked call, and uncovered call.

Like other short premium options strategies, short call sellers benefit from time decay, which can decrease the option’s value, allowing you to buy to close at a lower price, for a potential profit. A short call can be a more affordable way of getting short exposure to a specific asset without having to short shares outright.

You can also profit if the short call is closed or covered for a debit less than the total credit
received. If the short call expires worthless, you achieve maximum profit. You can see losses if the short call is closed for a debit more than the total credit received.

The maximum possible loss for a short call is unlimited because the underlying asset, in
theory, can rise in price infinitely. If a short call expires ITM by $0.01 or more, each short call will face assignment and convert to 100 short shares per contract, resulting in short stock risk with unlimited potential loss.

Long call option

Buying a call option gives you the right, not the obligation, to buy 100 shares of the underlying asset at the strike price on or before the expiration date. The call option’s value can increase as the price of the underlying rises and approaches the strike price or goes above it. That makes it a bullish strategy.

On the other hand, the call option’s value can decrease when the underlying’s price drops or stays the same. Out-of-the-money (OTM) calls are generally cheaper than in-the-money (ITM) calls because they only have extrinsic value. ITM calls have intrinsic and may have extrinsic value, which makes them more expensive.

You can profit if the long call can be closed for a credit greater than the total debit you paid before expiration. The maximum possible profit is unlimited because the underlying asset, in theory, can rise in price infinitely. You can see losses if you close the long call
before expiration for a credit less than the total debit you paid. You will lose the debit paid if it expires OTM.

If a long call expires ITM by $0.01 or more, each long call will auto-exercise and convert to 100 long shares per contract. You will assume the risks of holding long stock. If the long call was used as a protective strategy for 100 short shares, your short shares will be covered at the strike price, and you’ll no longer be short the stock.

Short put vertical spread

A short put vertical spread is a bullish to neutral options strategy utilising two put contracts with the same expiration date but different strike prices. This defined-risk approach involves you selling a put option closer to the underlying asset's price whilst simultaneously buying a cheaper, further out-of-the-money put for protection. The combination results in a net credit when you establish the position.

Your primary objective is for the underlying asset's price to rise or remain stable, causing the spread to lose value and ideally expire worthless. This outcome allows you to profit from the initial credit received. You achieve maximum profit when both puts expire out-of-the-money, letting you keep the entire credit.

The long put acts as a hedge, limiting your maximum potential loss to the difference between the strike prices minus the initial credit received. This occurs if both puts expire in-the-money. However, risks still exist, particularly if the underlying price falls between the two strike prices at expiration. In this scenario, your short put may be assigned, resulting in you assuming ownership of the stock.

You can also realise profits or losses by closing the spread before expiration, depending on whether the closing debit is less or greater than the initial credit.

Long put vertical spread

In a long put vertical spread, a bearish options strategy, you buy a put option closer to the underlying asset's price and sell a cheaper put further out-of-the-money, both with the same expiration. This results in a net debit when you establish the position.

Your aim is for the underlying asset's price to fall, increasing the spread's value. The strategy's advantage is its lower cost compared to buying a put outright, as selling the OTM put offsets some expense. However, this also caps your maximum profit potential.

Your maximum gain occurs when both puts expire in-the-money, equaling the spread's width minus your initial debit. On the other hand, your maximum loss is limited to the initial debit paid if both puts expire worthless. If the asset's price settles between your strike prices at expiration, you might find yourself with a short stock position, which carries significant risk.

You can realise profits or cut losses by closing the spread before expiration, depending on whether the closing credit exceeds your initial debit.

Short call vertical spread

When you implement a short call credit spread, you're employing a defined-risk bearish to neutral strategy. You'll sell a call option closer to the underlying asset's price and buy a cheaper call further out-of-the-money, both sharing the same expiration.

This setup generates a net credit for you, as the short call is pricier than the long call. Your goal is for the underlying asset's price to decrease or remain stable, causing the spread to lose value and ideally expire worthless, allowing you to pocket the initial credit as profit.

The long call serves as a safeguard, limiting your potential losses from the short call. Your maximum profit is capped at the credit received if both calls expire out-of-the-money. However, be mindful that your maximum loss occurs when both calls expire in-the-money, equaling the spread width minus your initial credit.

You must exercise caution, as you risk short stock assignment if the underlying price settles between your strike prices at expiration, potentially leading to significant losses. You can manage your position by closing the spread before expiration, realising profits or cutting losses depending on whether the closing debit is less than your initial credit.

Long call vertical spread

When you implement a long call vertical spread, you're employing a bullish strategy utilising two call options with identical expiration dates. You'll buy a call option closer to the underlying asset's price and sell a cheaper call further out-of-the-money.

This results in a net debit for you, as the long call is pricier than the short call. Your objective is for the underlying asset's price to rise, increasing the spread's value. The strategy's advantage lies in its lower cost compared to buying a call outright, as selling the OTM call offsets some expense. However, this also caps your maximum profit potential.

Your maximum gain occurs when both calls expire in-the-money, which is the spread's width minus your initial debit. On the other hand, your maximum loss is limited to the initial debit paid if both calls expire worthless. If the asset's price settles between your strike prices at expiration, you might find yourself with a long stock position, which carries its own risks.

You can realise profits or cut losses by closing the spread before expiration, depending on whether the closing credit exceeds your initial debit.

Covered call

When you implement a covered call strategy, you're selling an out-of-the-money call option for every 100 shares of the underlying stock you own in your portfolio. This approach allows you to generate potential income on your long shares, but it does cap your profits if the call goes in-the-money, as you're obligated to sell your shares at the short strike price.

You're still exposed to the risk of the underlying price dropping, though. If you sell a call at a strike below your cost basis, you could face locked-in losses if the shares are called away early or if the option expires in-the-money. However, you can profit if the shares are called away at a strike price exceeding your cost basis.

You might also profit by closing the short call before expiration for less than the credit you received, though you'll still carry the risks of holding the stock. It's crucial to remember that you retain long stock risk with a covered call; if the share price falls below your cost basis, you'll incur losses. While the gain from the short call can offset these losses to some extent, it may not be sufficient to cover them entirely.

Covered put

When you employ a covered put strategy, you're selling an out-of-the-money put option for every 100 short shares of the underlying stock in your portfolio. This approach allows you to generate potential income on your short shares, but it does cap your profits and still exposes you to unlimited risk due to the short stock position.

As the put seller, you're obligated to buy the underlying at the option's strike price, which will cover your short shares if the long holder exercises early or if the option expires in-the-money. If you sell a put at a strike above your short stock trade price, you could face locked-in losses if you're put long shares by assignment.

You can profit if the put expires in-the-money at a strike price below your short stock price, or by closing the short put before expiration for less than the credit received. However, you'll still carry short stock risk. It's crucial to remember that despite the potential for interim income, you still face unlimited risk on the short shares, potential borrowing costs for short shares, and dividend risks if the underlying pays one.

Options trading tips: what you need to know before trading

Regardless of which strategy you decide to implement, there are a few key things that you should do before you start to trade:

1. Learn how options work
2. Build an options trading plan
3. Create a risk management strategy

Learn how options work

Options are divided into two categories: calls and puts. Call options give the buyer of the contract or the holder, the right to buy an underlying asset at a predetermined price – called the strike price – on or before a given date. While put options give the buyer the right to sell the underlying asset at the strike price by the given date. Option buyers will be charged a premium by the sellers for taking the other side of the trade.

Learn more about how options work

Build an options trading plan

A trading plan is the blueprint for your time on the markets, which will govern exactly what, when and how you’ll trade. Your plan should be unique to you, your goals and risk appetite.

By creating an options trading plan, you’ll know exactly how much capital you can commit to each strategy and how much risk you’re willing to take on with each position.

A trading plan also eliminates many of the risks of trading psychology. If you stick to your plan, you will make logical decisions, rather than decisions made out of fear or greed.

Discover how to create a successful trading plan

Create a risk management strategy

Whichever options strategy you choose, it's vital to understand the risks associated with each trade and create an appropriate risk management strategy before you trade.

The most important factors that can help you measure the risk of each of your positions are called the ‘Greeks’. These are:

• Delta, which measures the sensitivity of an option to the underlying price
• Vega, which measures an option’s sensitivity to market volatility
• Theta, which measures the impact of time to expiry on an option’s value

You can trade US-listed options with us, or you can trade on options using contracts for difference (CFDs) or spread bets.

These enable you to trade using leverage, which can magnify your potential profits, but it can also magnify your losses – meaning it’s even more important to be aware of the risks of each trade.

We offer a range of tools available for you to manage your risk, including stops which close your trade automatically, and limits which allow you to lock in a profit.

Learn more about risk management

Start options trading

Now that you’ve chosen your strategy and followed the tips for trading options, it’s time to put what you have learnt to use.

With us, you can trade US-listed options, or you can trade on options using spread bets or CFDs. Remember, when using spread bets or CFDs to trade on options (instead of trading listed options directly), you’re speculating on the underlying options price, rather than entering into a contract yourself. This means that you won’t receive a premium for selling options when trading via these derivatives, which may impact some of the above strategies.

If you feel ready to start trading, you can open a live IG account.