What Is the Lowest Risk Options Strategy?
O ptions are a great investment choice if you’re new to investing, enabling you to get your feet wet in the trading world while offering a hedge against too much risk. With options, you can buy or sell stock at a specific price along a pre-set timeline. You can choose to buy the stock, sell it, or let it expire. In any case, you won’t lose much, and you stand to gain a decent profit if you choose to sell at the right time. Explore several of the lowest-risk options strategies you can implement to decrease risk and maximize profits.
The top six lowest-risk option strategies are:
- Covered call.
- Bear put spread.
- Protective collar.
- Married put.
- Bull call spread.
- Long call butterfly spread.
What Are Options Strategies?
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An options strategy is an approach a trader takes when buying and selling different options. Options are a form of investment in which a trader or investor purchases a contract that gives them the ability to buy or sell a security at a set price within a certain time frame. Each option gives the holder the right to 100 shares of a particular stock. To purchase an option, buyers (option holders) must pay a premium to the option seller (option writer). If the market doesn’t reach the target price for a stock, the option holder can let the option expire and won’t lose more than the premium they paid.
There are two types of options you need to be familiar with when investing in options: call options and put options. A call option is when the buyer purchases the right to buy the asset at the set price (strike price) within a set time frame. A put option is when the option buyer purchases the right to sell the asset at the strike price.
6 Low-Risk Options Strategies and How They Work
Traders can utilize several options to limit their risk and increase their chances of making a return. Taking advantage of these strategies gives traders more power and flexibility when investing in stock options. The following are the top six lowest-risk options strategies every options trader should be familiar with:
1. Covered Call
A covered call is a popular strategy among both new options traders and traders wishing to generate reliable income since it’s relatively safe and low-risk. It’s when the trader selling call options maintains ownership to an equivalent amount of the underlying asset being sold.
To execute this options strategy, you need to hold a long position in an underlying asset, and then sell (write) the call option to an option buyer at a set price and on a specific date. When the call option is sold, you immediately receive the premium on the sell, and if the stock remains the same price or decreases in price, you also gain a profit.
The option buyer only profits if the asset rises to a specific amount within the set time frame. This means that selling the call option gives you a better chance to profit than if you were to purchase the call option.
2. Bear Put Spread
The bear put spread is when a trader or investor purchases put options for an asset and also sells options for the same asset at a lower strike price and the same expiration date. [BUBBLE QUOTE] Bearish investors commonly use this options strategy to minimize their losses while maximizing profits. The investor makes a profit when the value of the asset or security decreases.
This options strategy helps to minimize the risk by offsetting the cost of purchasing the put option with a reduced strike price by selling it at an even lower strike price. As a result, the total capital used in this strategy is less than what it would take to simply purchase the put option.
The bear put spread options strategy is only successful if the underlying asset falls to the expected price before the option’s expiration date. If the price falls lower than what was anticipated, the investor loses the additional profit opportunity.
3. Protective Collar
A protective collar options strategy is when a trader purchases an out-of-the-money (OTM) put option while also writing an OTM call option. In layman’s terms, this means that the trader sells a call option that has a strike price higher than the current market value and purchases a put option with a lower strike price than the market value of that asset. Both options must be purchased and sold for the same underlying security with the same expiration date.
This options strategy is frequently used by traders following a long position in an asset that has recently seen large gains. It gives traders downside protection by locking in the potential sale price with the long put option. One downside to this strategy is that traders may have to sell their shares at an increased cost, which could limit or eliminate future profits on those shares.
4. Married Put
A married put options strategy is similar to the covered call strategy, but rather than selling a call option, the trader is purchasing a put option. In this strategy, an investor will buy the asset, and at the same time, purchase put options for the same amount of shares. The option holder then has the right to sell the stock at the strike price.
Investors sometimes use this strategy to protect any downside risk associated with holding a stock. The married put strategy sets a price floor in case the stock’s value drastically decreases. The profit potential with this strategy is essentially limitless and comes with very low risk even if the shares fall in value.
5. Bull Call Spread
A bull call spread strategy is the opposite of a bear call spread. It’s when an investor purchases call options at a certain strike price while simultaneously selling the same number of call options at a higher strike price. Both call options must have the same underlying asset and expiration date. This options strategy is also what’s known as a vertical spread and is typically used by traders who are anticipating a price rise for a particular asset.
This strategy allows investors to limit their upside and reduce the total premium spent to purchase the call option by receiving an instant premium for call options sold.
6. Long Call Butterfly Spread
A long call butterfly spread strategy combines both a bear spread strategy and a bull spread strategy while also using three different strike prices. These strike prices include one price that’s more than the market price, one that’s lower than the asset price, and one that’s equal to the asset’s market price.
For example, a trader may use this strategy by buying a single in-the-money call option at a reduced price. At the same time, the trader will sell two at-the-money call options and purchase a single out-of-the-money call option. Traders typically use this more advanced trading strategy when they anticipate a stock will remain within a certain range until the expiration date.
This strategy is slightly riskier than the previous strategies discussed. The total profit made from this strategy will be deducted from the commissions paid in the options contracts that were purchased. The maximum risk of this strategy is seen if the stock falls below the lowest strike price or rises above the highest strike price. In both cases, the options contracts expire and the investor loses the capital used to buy the contracts.
There are several options strategies that are low risk and offer traders a hedge against their investments. Understanding each strategy and determining the strategy that works for you is key to succeeding in options trading.