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Two of the most basic
option trades, are buying a call or buying a put. If
you think the market is going up, you buy a call. If you
think the market is going down, you buy a put.
A Bull Call Spread is
also a pretty basic option trade. If you think the
market is going up, but you want to limit your cash
outlay on the option, you can buy a call and simultaneously
sell a further out of the money call. Although your risk
is reduced by spending less, your profit is also limited
to the difference between the options because the option
you sell will also be gaining in price as the option you
bought gains in price.
If you think the market
is going down, and you want to limit your cash outlay,
you can try a Bear Put Spread. It is the opposite of the
Bull Call Spread, and you would buy a put and
simultaneously sell a further out of the money put. Your
profit is also limited in this trade.
Two more basic option
trades are called a strangle and a straddle. This is
where you simultaneously buy a put and a call. Either at
the money or slightly out of the money, respectively.
This is best in a sideways market, and if there is a
major breakout to one side, that particular option
should gain more than the other looses.
Using options as
insurance should be on everyone's list as the most basic
option trade. If you buy a contract on a commodity, you
can buy an opposing option (like being long on a
contract and buying a put). That way if you are wrong,
the option will gain in value and help limit your
losses. Stops should also be used on the contract, and
hopefully the option will continue to gain in value.
Also, a stop will not always get you out at a specified
price, especially in a fast market. If you are right,
you will have to make back the price of the option
before seeing a profit unless you sell it sooner.
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