Option trading is structured to allow traders and investors the ability to leverage their money. This makes option contracts a good tool for hedging or protecting large stock positions. That same leverage also makes them tools for speculation. The growing sophistication of the option market allows traders to access many different trading strategies. 

This wide array of strategies can be confusing to beginning option traders, so it is helpful to divide the strategies into categories. Three styles were discussed in the previous part of the Beginners Guide. 

Category 1, Delta style trading, is used to emphasize opportunities for using leverage.

Category 2, Theta style trading, is used to emphasize income opportunity from time decay. 

Category 3, Gamma style trading, is used to emphasize speculation opportunity. 

Let’s take a closer look at each category.

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Delta trading strategies are mainly designed to speculate on the normal price movement of stocks. The two most commonly used option trading strategies are the most straightforward ones: buying a call option, or buying a put option. Buying a call option leverages an upward move in the price of a stock, while buying a put option leverages a downward move.

However, these straightforward trading strategies have the challenge of time decay. Option prices lose value over time, so effective delta trading strategies need to overcome that challenge. Here are the four most commonly used delta trading strategies that overcome time decay.

• Buying in-the-money call or put options
• Buying vertical spreads 
• Buying calendar spreads
• Buying diagonal spreads

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Theta trading strategies help traders generate income opportunities because they rely on the most consistent aspect of option pricing: time decay. Theta-style strategies take the approach of selling options rather than buying them. 

If you buy an option, some of what you pay for includes the amount of time left before the option expires. So it stands to reason that if you sell an option, you are collecting the value of that time. Theta strategies emphasize the collection of that time value. Here are the most commonly used theta trading strategies that seek to collect time decay.

• Selling covered calls
• Selling out-of-the-money call or put options
• Selling vertical spreads
• Selling Iron Condors

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Gamma trading strategies are designed to capture highly speculative moves that represent larger opportunities than other strategies. Gamma trading strategies tend to be more effective when they emphasize time frames that are closer to the expiration date.  That’s because options with more time left to expiration have lower gamma scores. 

Traders who seek to capture speculative moves also like to limit their risk to relatively lower starting prices in their option trades. The most common gamma trading strategies for this include

• Buying out-of-the money call or put options
• Buying call or put options with less than three weeks to expiration
• Buying out-of-the-money diagonal spreads
• Day-trading options one or two days before expiration

There are many more strategies that can be classified into these three styles of trading. It is important to know the emphasis for each option trading strategy. No matter how complex an option trading strategy can become, it usually has the emphasis of one of the three trading styles.

It is also important to know that not all option trading strategies are available to the beginning option trader. Brokers allow different levels of trading authority based on a trader’s profile of available funds, investing horizon and experience in the markets. To learn more about how a trader acquires option trading authority from a broker, be sure to check out the next part of the Beginners Guide.

Option trading is structured to allow traders and investors the ability to leverage their money. This makes option contracts a good tool for hedging or protecting large stock positions. That same leverage also makes them tools for speculation. The growing sophistication of the option market allows traders to access many different trading strategies. 

This wide array of strategies can be confusing to beginning option traders, so it is helpful to divide the strategies into categories. Three styles were discussed in the previous part of the Beginners Guide. 

Category 1, Delta style trading, is used to emphasize opportunities for using leverage.

Category 2, Theta style trading, is used to emphasize income opportunity from time decay. 

Category 3, Gamma style trading, is used to emphasize speculation opportunity. 

Let’s take a closer look at each category.

————————–

Delta trading strategies are mainly designed to speculate on the normal price movement of stocks. The two most commonly used option trading strategies are the most straightforward ones: buying a call option, or buying a put option. Buying a call option leverages an upward move in the price of a stock, while buying a put option leverages a downward move.

However, these straightforward trading strategies have the challenge of time decay. Option prices lose value over time, so effective delta trading strategies need to overcome that challenge. Here are the four most commonly used delta trading strategies that overcome time decay.

• Buying in-the-money call or put options
• Buying vertical spreads 
• Buying calendar spreads
• Buying diagonal spreads

————————-

Theta trading strategies help traders generate income opportunities because they rely on the most consistent aspect of option pricing: time decay. Theta-style strategies take the approach of selling options rather than buying them. 

If you buy an option, some of what you pay for includes the amount of time left before the option expires. So it stands to reason that if you sell an option, you are collecting the value of that time. Theta strategies emphasize the collection of that time value. Here are the most commonly used theta trading strategies that seek to collect time decay.

• Selling covered calls
• Selling out-of-the-money call or put options
• Selling vertical spreads
• Selling Iron Condors

——————————

Gamma trading strategies are designed to capture highly speculative moves that represent larger opportunities than other strategies. Gamma trading strategies tend to be more effective when they emphasize time frames that are closer to the expiration date.  That’s because options with more time left to expiration have lower gamma scores. 

Traders who seek to capture speculative moves also like to limit their risk to relatively lower starting prices in their option trades. The most common gamma trading strategies for this include

• Buying out-of-the money call or put options
• Buying call or put options with less than three weeks to expiration
• Buying out-of-the-money diagonal spreads
• Day-trading options one or two days before expiration

There are many more strategies that can be classified into these three styles of trading. It is important to know the emphasis for each option trading strategy. No matter how complex an option trading strategy can become, it usually has the emphasis of one of the three trading styles.

It is also important to know that not all option trading strategies are available to the beginning option trader. Brokers allow different levels of trading authority based on a trader’s profile of available funds, investing horizon and experience in the markets. To learn more about how a trader acquires option trading authority from a broker, be sure to check out the next part of the Beginners Guide.