Reducing Risk With Stock Options

Gaining a real understanding of options is the first step to using them effectively. Many investors don’t realize that option trading strategies are designed to reduce risk, not increase it. Option trading in its original form was strictly method of protecting profits and laying off risk on the option writer.

Over the years the understanding of options has become associated with embracing risk rather than reducing it. Option trading has become merely a speculative activity rather than understanding options for their true original purpose.

Here Are Three Option Trading Strategies Designed To Reduce Risk

1. The Covered Call

This strategy involves the selling of call options on stocks that you are holding long. If you own the stock first, the position is called an overwrite. One call option is sold per 100 shares of stock. It is generally used when the trader feels bullish on the underlying stock. If you build the covered call position by selling the call and buying the stock at or about the same time, the strategy is called a Buy Write.

2. The Protective Put

This is the same thing as buying an insurance policy on your profits. The trader simply buys one put per 100 shares of stock at the strike price desired to lock in the profits. Should the stock drop, the put will increase in value effectively insuring your profits to a degree.

3. The Covered Call Collar

This is a combination of the covered call and protective put. A protective put is purchased at the same time the covered call position is established. The best way to do this is to write an out of the money call whose premium will cover the purchase of the put.

There are a variety of variations on the above option trading strategies but they are all designed to reduce risk.