Put & Call Options Trading: Essential Strategies & Tips

Put and call options trading can offer a creative and lucrative way to profit from investing in securities. While there is a significant level of skilled required, if you are willing to dedicate a modest amount of time to learning, you can gain a rudimentary understanding. Experience is the best teacher, but the following tips can help you to both avoid common mistakes and make more effective trading decisions.

Track the VIXX

The VIXX is a measurement of the prevailing level of volatility in the broad market as measured by the S&P 500. When the general market experiences spikes in volatility, options on most individual securities will spike as well, causing prices to spike. During periods of unusually high volatility, you should consider closing existing positions at a premium, unless there is a compelling reason to leave the position active. These periods are not a good time to by options.

Track Implied Volatility

Implied volatility is the level of volatility that the price action in the option suggests exists in the underlying security. There are several reasonably priced services that provide traders with implied volatility readings. Tracking this statistic and comparing it to the real, measured volatility statistics that are present in the market can reveal trading opportunities when these numbers diverge or show a break in their typical relationship.

Hedging with Puts Can Be Expensive

While buying puts is a popular and often effective way to hedge a long position that you wish to maintain, while still protecting against a downside move, this approach is often prohibitively expensive. Rather than looking to simply buys puts, an alternate, but effective, way to create a similar hedge is to use a spread. This can be done in such a way as create a credit, or be done for a small debit, depending on the specific parameters required. In either case, this approach can allow you to build a protective position without paying away such a high percentage as to make the transaction unreasonable.

Natural Skew Can Create Profit When Selling Calls

Skew is the price difference between calls and puts on the same underlying security when the strike price of each is an equal distance away from the prevailing market price. When the calls trade at a slight premium, it implies that the market has an underlying long bias. When the puts trade at the same premium, the bias is to the downside. Most stocks, however, trade with a slight and continuous long bias because the company is believed to be more likely to survive and appreciate than disappear.

This means that there is a natural amount of long skew – the result is that calls tend to trade at a small premium to similarly situated puts. This can be used to a trader’s advantageous when selling calls because the premium received can outpace the premium that would be paid for puts. This amount is usually too small to have a significant impact on trading decisions, but it should be considered. In rare cases, it gives the trader an insight into the market’s view on the future performance of the underlying and can be exploited.