Edit: This post has been updated for accuracy and comprehensiveness.
1. Stock- Oriented Strategy – Covered Straddle
– Normally price rise, sell shares to realise profit. Price drop, buy more shares.
– BUT Alternative to waiting for price rally/ dip → can use COVERED STRADDLE
→ Call + Put with the same strike price and expiration date
– Buy both Call + Put
– depending on the underlying stock’s direction of movement, either the call will profit more than the put (vice versa)
– write (sell) both Call + Put
– the hope is that the underlying stock does not move, and both options decline in price due to time decay
– earn from the premium collected when writing the 2 options
– if the underlying stock declines, put option kicks into effect, as a put writer (seller) , I have to buy back the stocks
– if the underlying stock rises, call option kicks into effect, people will want to use the call option to buy the stocks at a lower price, as a call writer (seller), I have to sell the stocks at the promised price (strike price)
– (long stock + cash) and short straddle
– can use the long stock to “cover” the Short Call part
– use the cash to “cover” (i.e. purchase) the Short Put part
READ: OPTION PRICE BEHAVIOUR
2. Stock- Oriented Strategy – Stock Repair
– Stock price declines – rather than holding on to the stock and waiting for price rally – I can initiate “stock repair” by DOUBLING UP.
– i.e purchase an equal number of shares at the current, lower price
– this is to lower the average cost of purchase (lower Breakeven Price)
-But this strategy costs money, and if stock continues to decline, then double the loss
– Cheaper option to “stock repair” via Options
→ Buy 1 call and sell 2 calls at different strike price → net should be zero cost
→ since we just want to protect against stock declines, then buying calls is not an issue. If the stock drop to below strike price, then they expire worthless.
READ: OPTION EXPIRATION
3. Stock- Oriented Strategy – Alternative to buying stock on margin → LEAPS
– LEAPS: long- term options → expiration dates more than 9 months away & LEAPS have fewer strike prices than shorter- term options
– Why use LEAPS instead of buying stocks on margin?
→ lower cost, no margin call risk and lower delta
→ CONS: not able to receive dividends and unable to vote in corporate affairs
Credits: CBOE Options Institute Online Learning Center – Trading Strategies