Best Options Trading Strategy
This simple, profitable trading guide teaches stock options trading for beginners. The strategy applies to the stock market, Forex currencies, and commodities. In this article, you will learn about what options are, how to buy Put and Call options, how to trade options and much more. If options trading isn't for you, try our Harmonic Pattern Trading Strategy. It's an easy step by step guide that has drawn a lot of interest from readers.
The Trading Strategy Guides team believes this is the most successful options strategy. When trading, we adhere to the principle of KISS: “Keep it simple, Stupid!”
With simplicity, our advantage is having enormous clarity over price action.
We’ll be focusing on BUYING Put and Call options through this options trading tutorial. Selling options is a different animal. It requires more experience to fully understand the inherited risks. Why? Because you can’t control the downside, the same way you do when you buy Put and Call options.
This is the most successful options strategy because it consistently provides profitable trade signals. Not because it doesn’t have losses. The preferred time frame best options trading strategy is the 15 minute time frame.
We will first define what buying a Put and Call options is. After that, we will give out the rules for the best options trading strategy. Here is another strategy called The PPG Forex Trading Strategy.
What are Options?
Options are a specific type of derivatives contracts. The underlying securities can be stocks, indexes, ETFs or commodities. With a derivatives contract, you do not directly own the underlying asset. Instead, you own a related asset whose value is affected by changes in price.
With an options contract, you have the right to buy or sell an asset at a predetermined price in the future. When that future point arrives, you will have the choice to exercise the option or let it expire.
Here's an example. Let's say the asset is selling for $110, a contract giving you the right to buy at $100 will have an intrinsic value. As the expiration date approaches, the value of the options contract will adjust.
There are two different types of options, call options and put options. When used correctly, options trading will make your strategy much more dynamic. Let's dive into the next section.
What is a Call Option?
A Call Option gives you the right to purchase an asset in the future. If exercised, this purchase will occur on a predetermined date. It will also occur at a predetermined value. If you are unsure about the future value of an asset, a call option can offer some protection. Call options are commonly purchased by stock traders. However, they can also be found in many other markets. In fact, call options are the most commonly traded options contracts.
What is a Put Option?
A Put Option gives you the right to sell an asset in the future. Like call options, these contracts have predetermined prices and sell dates. Put options and call options are often purchased together in order to make a “hedged” position. Below, we will discuss the different types of options sales. We will then discuss how these sales can be introduced into your trading strategy. You may also enjoy this article about options vs futures.
Different Types of Option Sales
It is necessary to remember that an option is a contract that allows you to purchase an asset at a specific price in the future. There are four different types of options sales that can possibly occur. The differences between short and long sales, and puts and calls will be very important.
- A long call option will give you the right to buy an asset at a specific price in the future. Long call option holders will benefit from price increases over time.
- A long put option will give you the right to sell at a specific price in the future. Contrary to call options, long put option holders are hoping that market prices will decrease.
- A short call option gives you the right to sell not the underlying asset, but the option itself in the future. Because the “logic” of short positions is reversed, short call option holders are in similar positions to long put option holders.
- A short put option will hope that long put options become less valuable over time—consequently, holders will be rooting for prices to go up.
Once you can understand the different varieties of options sales, you will be able to engage in more complex trading strategies. These strategies will usually involve purchasing multiple different options in order to manage risk and increase the possibility of earning high returns.
Why Use Options?
Options are used for speculation or hedging. Hedge fund managers are notorious for using advanced risk management strategies to hedge their market exposure.
Options offer high leverage, giving you the chance to trade big contracts and potentially make more money. This is the same for Forex. You need a smaller initial investment than buying stocks outright. When buying options, the risk is limited to the initial premium price paid.
When using options, the risk is limited, but the potential profit is theoretically unlimited. Obviously, we say theoretically unlimited profits. But options prices are going to be range-bound within certain parameters. There’s no stock price to rise to infinity. Also, read this article on Paper Trading Options - The Secret to Riches.
Types of Options Strategies
You can take your trading beyond basic call and put options. That is the beauty of options trading. Other trading strategies include covered call, married put, bull call spread, bear put spread, and more. They can help you better manage your risk and seek new trading opportunities.
If you’re a versatile trader, take advantage of the flexibility that options trading can give you. Study the top 10 stock options trading strategies below:
- Covered Call Strategy or buy-write Strategy - implies buying stocks outright. At the same time, you want to sell call options on the same stock. The number of shares you bought should be identical to the number of call options contracts you sold.
- Married Put Strategy - implies buying stocks outright. At the same time, you will buy put options for an equivalent number of shares. The married put works like an insurance policy against short-term losses.
- Bull Call Spread Strategy - implies buying call options with a specific strike price. At the same time, you'll sell the same number of call options at a higher strike price.
- Bear Put Spread Strategy - it’s similar to the bull call spread but involves buying and selling put options. In this options strategy, you buy put options with a specific strike price. At the same time, sell the same number of put options at a lower strike price.
- Protective Collar Strategy - implies buying an out-of-the-money put option. At the same time sell or write an out-of-the-money call option for the same stock.
- Long Straddle Strategy - implies buying both a call option and a put option at the same time. Both options should have the same strike price and expiration date.
- Long Strangle Strategy - implies buying both an out-of-the-money call option and a put option at the same time. They have the same expiration date but they have different strike prices. The put strike price will typically be below the call strike price.
- Butterfly Spread Strategy - implies using a combination of the bull spread strategy and bear spread strategy. The classical butterfly spread involves buying one call option at the lowest strike price. At the same time, sell two call options at a higher strike price. And then sell one last call option at an even higher strike price.
- Iron Condor Strategy - involves holding a long and a short position in two different strangle strategies.
- Iron Butterfly Strategy - involves using a combination between either a long or short straddle strategy. At the same time, buy or sell a strangle strategy.
Now let’s turn our focus back to the most successful options strategy.
Let's define the indicators you need for the best options trading strategy. And how to use stochastic indicator.
The only indicator needed is RSI or Relative Strength Index.
Options trading is constrained by the expiration date factor. So it’s important to select a technical indicator that is suitable for options trading. The RSI indicator is a momentum indicator which makes it the perfect candidate for options trading. This is because of its ability to detect overbought and oversold conditions in the market.
The RSI indicator's location is on most FX trading platforms (MT4, TradingView). You will find it under the indicators library.
So, how does the RSI indicator really work?
The RSI uses a simple math formula to calculate the oscillator:
There is no need to go further into the math behind the RSI indicator. All we need to know is how to interpret the RSI oscillation. Basically, an RSI reading equal to or below 30 shows that the market is in oversold conditions. An RSI reading equal or above 70 shows the market is in overbought conditions. At the same time, a reading above 50 is considered bullish. On the other hand, a reading below 50 marks is considered bearish.
The preferred RSI indicator settings are the default settings with a 14 period.
Before we go any further, we always recommend taking a piece of paper and a pen and note the rules.
Let’s dive into the options trading tutorial….
Most Successful Options Strategy
(Rules for Buy Call Options)
Options Trading Tutorial Step #1: Wait 15-minutes after the stock market opens to establish your market bias.
The most successful options strategy isn’t focusing only on the price. But they also make use of the time element the same as we’re doing here.
The stock market opening price is usually the most important price. During the first minutes after the stock opening bell, we can note a lot of trading activity. This is because that’s the time when major investors are establishing their positions in the stock market.
Read Day Trading Price Action- Simple Price Action Strategy. You'll learn about a strategy that isn't restricted to the time element and focuses on price action. It's one of the most comprehensive guides to successfully trade stocks or other assets by simply using price action.
Our team at Trading Strategy Guides wants to develop the best options trading strategy. In order to do that, we have to think smarter. We have to track how the smart money operates in the market.
The best options trading strategy will not keep you glued to the screen all day. You only have to know when the stock markets open.
The NYSE opens at 9:30 EST or 1:30 PM GMT time for those trading from Europe.
This brings us to the next step in our options trading tutorial…
Options Trading Tutorial Step #2: Make sure the 15-Minute candle after the opening bell (9:30 EST) is bullish.
As we have established earlier, we only want to trade in the direction where the smart money is. If we’re looking for buying Call Options opportunity we want to make sure smart money is buying after the open. Conversely, if we’re looking to buy Put Options we want to see sellers appear right after the opening bell.
Important Note*: If we have an opening gap up it means the buying power is even stronger and we should put more weight on this trade setup.
Options Trading Tutorial Step #3: Check if the RSI is above 50 level – This is a bullish momentum signal.
We use the RSI indicator for confirmation purpose only. We want to make sure that once we have identified the bullish price action the momentum behind the move is confirmed by the RSI indicator. We’re not concerned with overbought and oversold conditions because the market can stay in these conditions longer than you can stay solvent.
In the chart above, we can note the RSI is well above 50 during the first 15-minutes of trading. The price action is confirmed by the RSI momentum reading.
Now, let’s jump and define where exactly we want to enter our buy a Call option.
Options Trading Tutorial Step #4: Buy a Call option right at the opening of the second 15-minute candle after the opening bell.
Now, that we have confirmation that smart money is buying we don’t want to lose any more time and we want to buy a Call option right at the opening of the next 15-minute candle after the opening bell.
As easy as it sounds this strategy only requires you to put 15-minutes of your time each day. You’ll either get a signal or not, but in order to take advantage of the best options trading strategy, you need to exercise discipline and don’t take any trades if you don’t have any signal.
So at this point, our trade is running and in profit, but we still need to define when to exercise our call option and take profit.
Options Trading Tutorial Step #5: Choose the nearest expiration cycle. For day trading choose the weekly cycle.
When you buy a Call option you also have to settle an expiration date, as part of that contract.
You might be asking yourself how to choose the right expiration cycle?
Well, because we’re most likely going to sell our Call option the same day as we have purchased it, it’s more appropriate to choose the weekly cycle.
Time to switch our focus to the most important part: Where to take PROFITS and sell your Call Options?
Options Trading Tutorial Step #6: Take Profit and sell the Call Option as soon as you have two consecutive 15-minute bearish candles.
Knowing when to take profit is as important as knowing when to enter a trade. We want to get out of our position as soon as we see the sellers stepping in. We measure this by counting two consecutive bearish candles as a sign of bearish sentiment presence in the market.
You don’t want to exercise your long Call option because you don’t want to own those share stocks, you just want to make a quick profit.
Note** The above was an example of a buying Call option using the options trading tutorial. Use the exact same rules – but in reverse – for buying a Put option trade. In the figure below you can see an actual Buy Put Options example using the options trading tutorial.
We’ve applied the same Step #1 through Step#4 to help us establish our trading bias and identify the Buy Put Option trade and followed Step #5 through Step#6 to identify when to sell your Call option.
Selecting the Options Contract that’s Right for You
Now that you understand how to successfully trade options, you will want to know how to choose the contracts that are right for you. All options contracts will have some degree of risk. This is especially true when trading binary options. This is due to the fact that options can potentially be worthless on their expiration date. The risk of trading options can be managed.
When selecting options, keep the following things in mind:
- Your personal level of risk tolerance
- Your desired trading timeframe (day trading, long-term trading)
- The volatility of each prospective asset
- Past returns on options contracts
Options contracts also have high levels of implied volatility. During the first 30 minutes of trading, options contracts experience large changes in value. When volatility is high, both the level of risk and potential reward will be higher. During this time, your trading strategy will need to be much more active. Risk can be managed by issuing stop orders. It can also be managed by hedging your position and diversifying your positions.
Both call and put options can be very rewarding. In order to prepare yourself as an options trader, it will be a good idea to practice. Fortunately, Trading Strategy Guides makes it easy to hone your skills and enter new markets. Carefully combining the steps mentioned above can help you unlock the best options trading strategy.
Conclusion - Options Trading Tutorial
This is one of the most successful options strategies because when trading stocks, it’s important to have a good understanding of the market sentiment and how the big players are positioned in the market. Another important reason why this is the best options trading strategy is that you’re not required to be glued to the screen all day long.
Don’t forget also to read our Support and Resistance Zones – Road to Successful Trading one of the most comprehensive guides to successfully trade stocks or other assets by simply using support and resistance levels.
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