Options and futures option trading strategies
But any experienced trader knows the unpredictability of earnings reports can open you up to more downside. And since trading is all about controlling risk, many traders use options strategies to protect themselves if a trade goes the wrong way.
Here are four popular options trading strategies that to use during earnings season. The covered call strategy is one way to protect against potential earnings downside at the expense of sacrificing a bit of upside. At the same time, if the stock falls on bad earnings, that option premium can help mitigate potential losses. A married put strategy is similar to a covered call in that you can buy shares of the underlying stock, and then immediately turn around and buy out-of-the-money put options against those shares.
For someone bullish on a stock ahead of earnings, a married put serves as a hedge against a large sell-off. Unlike a covered call, upside from a married put strategy is potentially unlimited. If the stock skyrockets, the value of the puts goes to zero, but the underlying stock position is the big winner.
If the stock tanks, the value of the put can increase. In a long straddle, one of the positions is likely to decrease in value though, if there is little to no movement in the stock price compared to the strike price, it is possible both positions will decrease in value , but the hope is that the stock will move so much in one direction that the winning position will more than make up the difference.
For example, if you own calls on a particular stock and it has made a significant move to the upside but has recently leveled out, you can sell a call against this stock if you are neutral over the short term. Traders can use this legging-in strategy to ride out the dips in an upward trending stock.
Plan your position size around the max loss of the trade and try to cut losses short when you have determined that the trade no longer falls within the scope of your forecast. This trade has limited upside when both legs are in play.
However, once the short option expires, the remaining long position has unlimited profit potential. It is important to remember that in the early stages of this trade, it is a neutral trading strategy.
If the stock starts to move more than anticipated, this is what can result in limited gains. As the expiration date for the short option approaches, action needs to be taken. If the short option expires out of the money, then the contract expires worthless. If the option is in the money, then the trader should consider buying back the option at the market price.
After the trader has taken action with the short option, he or she can then decide whether to roll the long option position. The last risk to avoid when trading calendar spreads is an untimely entry.
In general, market timing is much less critical when trading spreads, but a trade that is very ill-timed can result in a max loss very quickly.
Therefore, it is important to survey the condition of the overall market and to make sure you are trading within the direction of the underlying trend of the stock. In summary, it is important to remember that a long calendar spread is a neutral - and in some instances a directional - trading strategy that is used when a trader expects a gradual or sideways movement in the short term and has more direction bias over the life of the longer-dated option.
This trade is constructed by selling a short-dated option and buying a longer-dated option, resulting in a net debit. This spread can be created with either calls or puts, and therefore can be a bullish or bearish strategy. The trader wants to see the short-dated option decay at a faster rate than the longer-dated option. From Wikipedia, the free encyclopedia. Energy derivative Freight derivative Inflation derivative Property derivative Weather derivative.
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