The penultimate motto of any investor is to earn the highest possible profit from his invested money. Many scholars have defined various strategies, methods, and tactics for the same. One of the strategies is the options spread strategy. We shall first see the meaning of option spreads and then continue with types of option spread strategies.
In options spread strategies, Options Traders will either buy or sell multiple call options or multiple put options, having the same underlying asset. The options are nearly the same in various aspects, except their strike price, expiry date, or both.
The options in the financial sector are very famous, especially in the Indian market. The money invested in options of some indices are huge than in any other country in the world. So, let us get a brief detail of what options are, and then we shall see how to use them to get the best returns.
Options are the contract in which the holder of the contract has the right to buy or sell a lot of shares at a prefixed price known as strike price on some future date known as expiry date by paying a small amount known as premium for entering into the contract. In these contracts, the lot size of the stocks and expiry date both are determined by the exchange department.
Now, understand why a lot of people invest in the options, why there is so much popularity among the investors, and the reason is the amount of loss involved. Let us say, if the market is not in your favor, you only lose the amount you paid as the premium which is comparatively very low. On the other hand, if the market situation favors you, then you get a huge profit.
The only biggest enemy in this type of trade is the time factor; if it is taking too long for the situation to be in your favor and impact positively, then you should move to the options spread strategy. As this strategy has the potential of higher profit with limited loss amount, and also other factors do not hinder the trade.
What should you buy and sell in Options spreads?
It is recommended to buy the option of having the strike price nearest to the current market price of any underlying stock you choose. You can choose to sell those options which have fewer variations in their price to avoid the loss.
You can choose the options whose strike price for the call option is greater than the market price and similarly, for put options, the strike price should be lower than the current market price.
Let us see the types of Options strategies to better understand how to get the best returns.
There are mainly 3 types of Options spread strategy; they are Vertical Spread Strategy, Horizontal Spread Strategy, and Diagonal Spread Strategy.
A vertical Spread Strategy: This strategy is generally known as money spreads in the market. In this strategy Options, Traders make use of 2 options having different strike prices each but both expire on the same date. By implementing this strategy a trader can limit the risk involved, but by limiting the risk he also loses the potential earnings.
A horizontal spread strategy: In the real market, this strategy is commonly known as a Calendar spread. In this strategy, the options trader uses two options; one long and one short with the same strike price, but they both expire on different dates. The main goal of a calendar spread is to benefit from the time decay factor or theta. The theta explains what variation will arise in the price with the passage of time.
The options which are about to expire are more likely to be affected by the time factor than longer termed options. So if the trader has incurred a loss in the short-term trade, he can recover the same in the long-term option.
A diagonal spread Strategy: In diagonal Options spread strategy, the options trader enters into both long and short positions together. Both options are of the same type but have different strike prices and different expiries, It benefits from the time decay factor and also from the movements in the price at every step known by delta.
So, this was all about the Options Spread strategies and their types, and how the trader can get benefit by using the options spread instead of an option. If an option is taking 1 to 3 sessions to make you profit, and if the time factor is affecting the amount of profit at that time you can make use of the option spread strategy.