Advanced Options Trading Techniques: Three Strategies You Should Master

Introduction

While options might not be suitable for all traders, they can be amongst the most flexible investment choices. Keep in mind that whether you are seeking to grow your investments or hedging, you may use options to help reach the various goals and objectives that you set for your portfolio.

There are many advanced option trading strategies, such as spreads, butterflies, and iron condors, which will help you structure your exposure and risk to your objectives. Advanced options strategies, such as the bull call spread, are great ways to combine different options to produce positions that can profit from more than one direction.

For example, bullish options strategies are excellent as they allow you to profit when the underlying stock or security goes up. On the other hand, bearish options strategies will enable you to profit when the stock declines.

Key Stats

In Jan 2021, FIA released annual statistics showing the total number of options and futures traded on exchanges around the world reached a record level of about 47 billion contracts in 2020, up 35.6 percent from 2019. Did you know that total options trading increased 39.3 percent to 21.22 billion? Also, equity-related derivatives made up the majority of the rise in trading activity in 2020.

Options and futures on equity indices, the biggest category of the listed derivatives markets with respect to volume, reached 18.61 billion contracts in 2020, representing an increase of about 6.15 billion or 49.3 percent from 2019.

The Bull Call Spread

Designed as a debit trade, a bull call spread is perfect for a stagnant stock price or a neutral to slightly bullish stock market. You purchase one call option and simultaneously sell another call option with a higher strike price with the same date of expiration. A bull call spread comprises one long call with a lower strike price and a short call with a higher strike price. It involves buying an ITM (in-the-money) call option and then selling an OTM (out-of-the-money) call option with a higher strike price. We can define the strike price as the amount at which the option holder can exercise the option to purchase or sell an underlying security.

You should ideally target an expiration date that’s further out, say four to six months. Did you know that the bull call spread advanced options strategy is used when the options trader believes that the price of the underlying stock or asset will increase moderately in the near term? It is worth noting that profit is limited if the stock value increases above the strike price of your short call.

On the other hand, the potential loss is also limited if the stock or asset price falls below the strike price of your long call (lower strike price).

You can also consider the bull call spread a doubly hedged strategy. This is because the price you pay for the call that has the lower strike price is partly offset by the premium you receive from writing the call that has a higher strike price.  

As a trader, you may risk losing the entire premium you paid for the call spread. However, you can mitigate this risk by closing the spread before expiration. You can do this if the security is not performing as well as you expected. It will help you salvage some of the invested capital.

As a result, your investment in the long call vertical spread, as well as the risk of losing the whole premium you pay for it, is hedged or reduced.

Breakeven

Note that this strategy will break even at expiration if the stock price is higher than the lower strike by the amount of your initial outlay (or the debit). And in this case, your short call would expire worthless, while the intrinsic value of the long call would equal the debit.

Breakeven = long call strike plus the net debit paid

Alternatives before Expiration

You can sell a bull call spread bought as a unit for a net debit in one transaction in the options marketplace as a unit in another transaction for a credit, provided it has value. Did you know that this is generally how investors close a spread before its options expire to realize a profit or cut a loss?

Affect of Time Decay

It is worth noting that the impact of time decay on this options strategy varies considerably with the underlying stock's price level with respect to the strike prices of the long position and short option.

For example, if the stock price is about midway between the strike prices, the impact will likely be minimal. On the other hand, if the stock price is close to the lower strike price of your long call, generally, losses increase at a much faster rate with the passage of time. While the passage of time tends to hurt the position, it does not hurt as much as it does a plain long call position.  

Aggressive Bull Call Spread

Did you know that you can also enter into a more aggressive bull spread position? You can do this by increasing the difference between the strike prices of the 2 call options. However, keep in mind that this will mean the stock price has to move upward by a greater extent for you to realize the maximum profit. 

The Bear Put Spread

The bear put spread entails simultaneously selling and buying different put options of the same contract month. So, a bear put spread is a specific kind of vertical spread. You buy one put option in order to profit from a decrease in the underlying stock or asset and write another put option with the same expiration month but with a slightly lower strike price. This helps offset some of the cost.

And contrary to the bear call spread, in this case, you will pay the higher premium and get the lower premium. As a result, there’s a net debit in premium. This is why your risk is capped at the difference in premiums. On the other hand, your profit will be restricted to the difference in strike prices of your put option minus your net premiums.

So, the most that you will lose on a bear put spread is the amount of money you paid for it -- or the net debit. In contrast, the maximum loss occurs if the stock price closes on the expiration date at any point higher compared to the higher strike price.

You can use this strategy when you are bearish on the market to an extent (i.e., you think that the market has limited downside risk). In other words, you think that the price of the underlying stock or asset will decline moderately in the short term.

Assuming that the stock moves down towards the lower strike price, note that the bear put spread tends to work much like its long put component would work as a standalone strategy. In contrast, however, to a plain long put, the potential of greater profits stops there.

Keep in mind that this is a part of the tradeoff, and the short put premium helps mitigate the cost of the strategy while setting a ceiling or cap on your profits.

Risk of Early Assignment

You will be glad to know that the risk of early assignment with a bear put spread strategy is usually low.

In many cases, traders will purchase a bear put spread that’s out-of-the-money. As a result, they are not likely to suffer assignment on the short put. And in the unlikely event that a short put was assigned, the long put will cover the position in any event.

You should know that the only time assignment will likely happen is when your trade has gone deep in the money and is quite close to expiry.

Impact of Time Decay on the Trade

Remember that time decay can vary significantly depending on where the underlying stock price or asset is trading. Traders that place a standard out-of-the-money bear put spread tends to start their options trade with negative theta.

What does this mean? It means that a trader will lose money from time decay with the passage of time, with everything else being equal.

So, if the stock price is trading below the sold put strike price, then the position will gradually switch to having positive time decay. In this case, the passage of time will help the trade. On the other hand, if the underlying stock price is close to the lower strike price of your written put, generally, profits increase at a much faster rate as time passes, which benefits the trader.

Alternatives before Expiration

You can sell a bear put spread bought as a unit for a net debit in one transaction in the options marketplace as a unit in one transaction for a credit, as long as it has value. And this is generally how investors close a spread before its options expire to realize a profit or cut a loss.

The Impact of Implied Volatility on a Bear Put Debit Spread

Note that the bear put debit spread benefits from a rise in the value of implied volatility. This means that higher implied volatility causes higher options premium prices. In an ideal case, when you initiate a bear put debit spread, usually, implied volatility is lower than it is at expiration or exit.

Also, future volatility, also known as vega, is unpredictable and uncertain. Still, you should know how volatility will impact the price of the options contracts.

The Long Strangle

This strategy involves purchasing an at-the-money put and an at-the-money call in the same expiration month. Keep in mind that as you are combining a bearish trade (long put) with a bullish trade (long call), this is what makes it bi-directional.  

The Long Strangle (also known as Option Strangle or Buy Strangle) is often a neutral strategy where you buy slightly OTM Put Options as well as Slightly OTM Call Options simultaneously with the same underlying asset or security and expiry date.

You should know that buying only long puts or long puts is mainly a directional strategy. However, the long strangle consists of both long puts and long calls and isn’t a directional strategy; instead, it is used when you feel very large price swings or fluctuations are forthcoming but are unsure of the direction. 

As a trader, you look at the low implied volatility and feel that options are pretty cheap. And the thought process here is that this market will likely have a huge move. However, traders are not certain which way it will be. As a result, they decide to purchase both a call as well as a put.

A sharp increase in implied volatility usually accompanies large moves in stock prices. Surely, this benefits the long strangle as this strategy depends on higher implied volatility and movement in the price of the underlying security to collect larger premiums when you exit the trade.

However, because the position includes a long put and a long call, the trader using a long strangle must have a complete and in-depth understanding of the rewards and risks associated with both long puts and long calls.

Breakeven

To break even on a long strangle, note that the stock price has to be higher than the call strike price, or go below the put strike price, for either one of your option positions to have value. It is important, however, that you first recover or recoup the premium paid before you start to profit on this position.

Passage of Time

It has a negative impact. The time value part of your option's premium, which you have bought when paying for the options, usually decreases or decays as time passes.

Did you know that this decrease accelerates as your options contract gradually approaches expiration? This is why market observers will realize that time decay for puts occurs at a relatively slower rate than with calls.

Alternatives at Expiration

Note that by expiration, investors that hold a long strangle might decide to sell the options back to the market—possibly the put or call that hopefully has some intrinsic value, prior to the end of trading on the option's final trading day.

In contrast, an investor may also decide to exercise the put or call  (assuming that the stock price is above the call strike price or below the put strike price and then maintain a short stock position (a put exercise) or a long stock position (a call exercise).

The Impact of Implied Volatility on a Long Strangle

A long strangles benefits when there is an increase in implied volatility. Keep in mind that higher implied volatility leads to higher option premium prices. And ideally, when you initiate a long strangle, implied volatility should be lower than where it will be at expiration or exit.

Final Thoughts

There are many ways to trade options contracts, from puts and calls to premium paid and premium received. Keep in mind that learning how to implement the most suitable options strategies at the right time could help you take advantage of a variety of markets.

There is no doubt that options can be a useful tool, particularly in volatile markets. This is because they allow for greater leverage, enabling you to hedge your positions and even generate additional income. Check out my YouTube channel for more options trading strategies!

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