If you are a novice or even a professional investor or trader, you would agree that prices follow three patterns - a bullish, a bearish or a neutral movement. Irrespective of the news, change in fundamentals or technicals, prices have to follow a bullish, bearish or neutral trend.
Let's understand what these mean:
• A bullish trend is one where you expect a stock or set of stocks to move higher. If you are bullish, you are a buyer in the stock or stocks, which also means you hold long positions.
• A bearish trend is exactly the opposite. If you hold a bearish view, you want to be short or you have been selling or plan to do that.
• A neutral trend is neither bullish nor bearish, which means you are non committal.
What is a stock option?
A stock option is a type of derivative that gives you the right, but not the obligation, to purchase or sell a certain quantity of a particular stock. The purchase is at a predetermined price at a set date in the future.
Let's take a look at two bullish strategies.
a) Buying Calls
If you are bullish on a stock, you would be buying calls. When you buy a call, you possess a right to buy the stock at a specific strike price in the future. If price rises above the strike price at contract expiry, you make a profit, provided the price also covers the premium paid.
b) Writing Puts
When you write a put option, you work on assumption that the stock would not fall below the strike price. This is done in return for a premium. If the stock's price remains above strike, the person writing the Put makes a profit.
Bearish Stock Options Strategies
If you believe that markets and specific stocks are likely to fall, two popular bearish strategies would be writing calls and buying puts.
Let us understand these:
a) Buying Puts
When you buy a put contract, you have the right to sell shares at a strike price at some future point in time. If prices fall below the strike price, investors make a profit, provided you also factor in the amount of premium paid.
b) Writing Calls
When you write a call contract, you agree to buy shares at a strike price at some future point in time. As long as price remains beneath strike, the contract expires worthless, and the writer holds on to the premium. However, the risk is significant because the writer has a serious liability if the price rallies above strike.
Buying puts and writing calls are popular bearish stock options trading strategies.
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