There are hundreds of option strategies. And they can be vastly different in terms of tactics and desired outcomes.
But in fact, there are really only a few basic strategies, and everything else is built on these in some form. This range of possible strategic designs is what makes the options market so interesting, challenging, profitable... and also nice and risky.
Are you surprised by my characterization of risk as "nice?"
Well, "risk" and "opportunity" are really the same thing, and every option trader needs to accept this.
Because if you want to go fast and get some serious movement, well, you have to climb on board the rollercoaster first, even if it scares you a little bit.
In my last options trading strategies article I took the mystery out of long calls, long puts, covered calls, short puts and insurance puts.
But the truth is those are only five of the eight general strategies (and "families" of strategies) we use here At Money Map Press.
Today I'd like to tell you about the final three, explaining what you need to know about Leaps, spreads, straddles.
Let's get started with Leaps.
Understanding Leaps Options
This strategy can be an attractive alternative to the otherwise very short lifespan of most options. And the potential for gains in either long or short Leaps trades is substantial.
The Leaps, or long-term equity appreciation securities contract, is simply a long-term option.
They are available, as calls and puts, on 20 indexes and approximately 2,500 equities. The life span of a Leaps option is as long as 30 months. In the options world, that is something akin to "forever."
Leaps provide a lot of interesting strategic possibilities. You can open long Leaps call positions as a "contingent purchase" strategy, so 100 shares can be bought in the future. Or you can buy puts as insurance or as contingent sales positions.
The big disadvantage of a long-term option is going to be the very high time value – you have to pay for the luxury of a long-term play. This is true, at least, if you buy long-term contracts. But if you sell them instead, that high time value works in your favor.
That's why my favorite way to play the LEAPS is to sell an ATM call. Your return can be significant. And the premium provides a cushion that makes LEAPS sales very desirable, especially if it's part of a long-term contingency plan.
If you are willing to sell shares at a specific price at any time between now and two years from now, selling a LEAPS option brings in high current income and a desirable exposure to exercise.
Let me show you how this works.
In mid-February, shares of Google Inc. (NasdaqGS: GOOG) were at $610. The January 2014 610 call was trading at 99.60 - just under $10,000 per contract.
If you sell that call, that's a 16.3% return based on the strike, or 8.5% annualized [(16.3 ÷ 23 months) x 12 months = 8.5%]. So if you bought Google shares anywhere at or below $610, this is a very attractive net return.
There is also the chance that the stock price will decline below $610 over the coming 23 months. In that case, the premium value of the call would decline, and you could close your position for a nice profit.
Next, I'm going to explain the basics of spreads and straddles. That's where the hedging potential of these combined strategies comes in...