If you want to hammer in a nail, you use a hammer and if you want to screw in a screw, you use a screwdriver. Obviously you need the right tool to do the right job. This is universal and applies from DIY home improvement to your daily profession.
Trading is no different. As traders, we not only need to have the skill to pick direction, we need to have the right strategy to help us profit from our view. It makes sense to have a tool box full of strategies that can take advantage of any market condition and get the job done.
Typical equity investors and traders have a very simple and effective strategy; buy shares low, and sell them high. This is a great strategy for strong bullish markets, just as a hammer is great for hammering in nails.
So let’s compare how different strategies may play out against different views.
View 1 – Confident the stock is going to rise quickly over the next few days.
View 2 – Confident the stock will rise, but may do it slowly over the next few weeks.
View 3 – Bullish outlook, but very confident the stock isn’t going to drop below a certain point over the next month or so.
The great thing about Exchange traded Options is that there are strategies we can use to specifically tailor our view of the market.
I am going to give you a quick overview of a strategy each of these views. If you’d like to learn more, I will be running a special webcast teaching these strategies in detail, and showing you how to enter them into an options calculator.
View 1 – Call Option
A Call option when bought can be used to take advantage on stocks that are rising quickly. They are uncapped to the upside but have limited risk.
With a bought Call option, your risk is limited to what you pay to buy the Call option.
View 2 – Bull Call Spread
A Bull Call Spread can profit from both the stock rising and going sidewards. This flexibility allows time for the bullish movement to occur whilst still profiting. Both the risk and profits are capped.
View 3- Bull Put
A Bull Put can make profit from the stock rising and going sidewards. If setup correctly, it can even profit if the stock falls slightly. You can set up this strategy where all risk is placed below a particular share price. Come expiry, if the stock is above that level, you make the maximum profit on this trade. Profit and Risk is also capped on this strategy.
Comparing the Three
The Call option will provide the most profit to the upside in the short term. The Bull Call will do well on the bullish movement, making less than the Call option, but more than the Bull Put spread. The Bull Put spread will make less than the other two on bullish movement alone, but can profit from a wider range of scenarios including the stock falling to a point.
Ultimately, you can see that understanding these strategies and applying them to suit your specific view can provide a significant edge in trading the market.
Not to labour the DIY analogies, but if the only tool you’ve got is a hammer, then everything can start looking like a nail! It wise to have a range of trading strategies that allow you to match you trade exactly to your view of the market.
The webcast I’ll be running next Thursday will go into greater detail as to how these strategies work and when to apply them. Click here to book your spot.