Practical Guide to Options Trading Strategies

The Chicago Board of Options Exchange (CBOE) was founded in 1973 to create a formal market for options trading. Almost exclusively the domain of professionals and institutional investors, options trading started making its way to individual investors in the early 2000s.

That popularity took off in the late 2010s when brokerages eliminated commissions on most trades and then exploded in the early 2020s during the COVID pandemic, when the market was strong, money was plentiful, trading apps made it easy, and a lot of people had a lot of time on their hands.

In spite of this, options trading remains mysterious, even intimidating, to many. And that’s a shame because options trading is one of the most versatile and powerful tools available to investors and traders.

Unlike simply buying or selling stocks, options allow you to profit from a wide variety of market conditions—rising, falling, or even sideways prices. Options can be used for speculation, hedging, or generating income, making them a staple in the toolkit of sophisticated investors. This comprehensive guide will take you from the basics to advanced strategies, risk management, and practical tips, empowering you to use options with confidence and discipline.

Options are financial contracts that give the holder the right, but not the obligation (hence the “option”), to buy or sell an underlying asset at a specified price on or before a certain date. They derive their value from underlying assets such as stocks, ETFs, or indexes. For this reason, options are considered derivatives.

There are two types of options. A Call option gives the holder a right to buy the asset at a specified price. A Put option gives the holder a right to sell the underlying asset at a specified price.

Options offer several features that can be advantageous to investors. The most prominent of these advantages is leverage. An option provides control over a number of shares with much less capital than would be required to purchase the stock outright.

Other advantages of options include flexibility, which enables traders to profit from various market conditions, and risk management by using options to hedge existing positions against adverse price movements.

Options can be tailored to fit bullish, bearish, or neutral outlooks, and can be used to generate income, protect investments, or speculate on price moves. We’ll cover all of that in this section.

Right from the start, one of the things that turns off some investors is the jargon. The language of equities is more a part of our culture and therefore more familiar for most people. Understanding options requires familiarity with a few essential terms:

• Underlying Asset: The security the option is based on (usually a stock, ETF or index).
• Strike Price: The predetermined price at which the option can be exercised.
• Expiration: The date when the option contract ends (usually a Friday); after this date, the option becomes worthless if not exercised. Weekly options expire on Friday. Monthly options expire on the third Friday of the month. Quarterly options and LEAPS expire on longer-term dates.
• Premium: The price paid (by the buyer) or received (by the seller) for the option contract. Note that each option contract controls 100 shares of the underlying asset, so you multiply the premium by 100 to determine the cost of the contract.
• Direction: The direction indicates whether you are initiating or exiting a position and which side of the transaction you are on (whether you have taken on a right or an obligation).
• Buy to Open (Long): You’re initiating a new position with rights (buy a call or put).
• Sell to Open (Short): You’re writing an option and taking on obligation (sell a call or put).
• Buy to Close / Sell to Close: Used when exiting an existing position.
• Implied Volatility: The market’s forecast of likely movement in the underlying asset. Higher implied volatility (IV) increases option premiums.
• Time Decay: Options lose value as expiration approaches, especially out-of-the-money options. This is due to the decreased probability for a large price change over a shorter period.

Options Trading Example

Here’s an example of a description of a trade:

Buy 2 AAPL Jul 19 ’24 180 Calls @ $4.50

This means:

• You are buying to open a position, also known as a long position.
• You’re buying 2 contracts of Apple (AAPL) options (covering 200 shares)
• The options expire on July 19, 2024
• You are buying Call options so you have the right to buy AAPL at $180, but not the obligation.
• The premium is $4.50 × 100 × 2 = $900 total cost

We will refer back to this example throughout this article.

Options Risks and Rewards

There are a wide number of options trading strategies, each with a different risk/reward profile. We’ll talk about some of these later. For now, it’s important to understand the basics of how options can be used to generate benefits including profits and hedging or managing risk. And of course, since you don’t get something for nothing, what are the costs and risks of those benefits?

The risks and rewards of buying options are:

Buy Call (Long Call)

• Risk: Limited downside risk. You can lose the premium you paid, such as when the option expires worthless.
• Reward: Unlimited upside potential. You can buy a stock for less than the current market price, immediately creating a profit for you. In the AAPL example above, if the price rose to $200, you could purchase 200 shares for $180 each and immediately have a profit of $20 per share.
• When to Do It: When you believe the price of the stock will rise, above the strike price.
• Strategy: Bullish—expecting the underlying asset to rise.

Buy Put (Long Put)

• Risk: Limited downside risk. You can lose the premium you paid, such as when the option expires worthless, which happens when the price stays steady or increases.
• Reward: Substantial profit potential. If the stock price falls, you can sell a stock for more than the current market price, immediately creating a profit for you. Again, using the AAPL example, if the stock price falls to $150 you could sell the stock at 180, giving you a profit of $30 per share.
• When to Do It: When you believe the stock price will fall. This is similar to short selling in that you believe there is something that will cause the price to fall – market dynamics, sector rotation, mismanagement, etc., or simply that it is overpriced and the market will recognize that and adjust its valuation.
• Strategy: Bearish—expecting the underlying asset to fall.

And the risks and rewards of selling options are:

Sell Call (Short Call)

• Risk: You risk giving up a potential gain. The agreed upon strike price of the contract could be less than the current market price at expiration and the buyer would want to call away the agreed upon number of shares. If you already own those shares (what is referred to as a “covered call”) you will give up the upside (the difference between the market price and the strike price). If you do not own the shares (referred to as a “naked call”) you need to buy them in the market (at a higher price than the strike price you will receive) at a loss.
• Reward: You get the premium ($900 in the example above). If you sold a covered call you also receive any appreciation in the price of the stock between the price when you purchased it and the strike price – it would only be part of the total appreciation but it’s still better than nothing.
• When to Do It: When you think the price of the stock is going to stay steady or decline, causing it to expire out of the money.
• Strategy: Neutral to bearish—expecting the asset to stay flat or decline.

Sell Put (Short Put)

• Risk: If the stock were to fall below your strike price you are on the hook to buy the stock at that level, with downside exposure until the stock goes to zero.
• Reward: You get the premium.
• When to Do It: When you think the price of the stock is going to stay steady or go up, causing it to expire out of the money.
• Strategy: Neutral to bullish—expecting the asset to stay flat or rise.

These are highly simplified situations but they provide you with the basics to understand the risk and reward dynamics of each of the four primary quadrants of buying/selling calls and puts.

In addition to the less-familiar jargon, another thing that may keep people from trading options is the perception that they’re risky. Stories about bit options trading failures travel far and wide. And many are true.

My observation however is that many of the people who lose money trading options simply are under-educated or cavalier about their trading. Yes, you can lose money on options, just as you can lose money on stocks or any other investment. But smart traders learn to improve their odds of success with knowledge and discipline and to cut their losses short. Again – just like trading stocks.

A big difference between options trading and stock trading is the leverage options trading gives you. Going back to the Apple example, if you want to have the ability to control 500 shares of AAPL here’s what it would cost you:

Stock: 200 x $180 = $36,000

Options: 200 x $4.50 = $900

If the stock price rises to $200, you would spend $900 for the options and another $36,000 to acquire the shares at $180 per share, for a total cost of $36,900. But you would have shares worth 200 x $200 = $40,000, for a gain of $3,100 (8.4%). Importantly, you would spend the $36,000 to purchase the shares only if you knew you were going to make a profit, and the only money you put at risk is $900.

By contrast, if you purchased the stock outright at $180 and it rose to $200 you would make a profit of $4,000 (200 x $20) but that would tie up $36,000 of your money. That’s a lot more that you’ve put at risk. And, if instead of rising the price fell to $150, you would be down $6,000 (-$30 x 200 shares). With the options the most you would lose is $900.

At the risk of stating the obvious, holding an option for a stock does not give the holder the right to vote as a shareholder. It also doesn’t make you eligible to receive dividends. Those rights only vest when you exercise the option to purchase the stock.

The Greeks

There are a number of Greek terms that are used in relation to options trading. The Greeks are a set of measures that help assess the sensitivity of an option price to various factors. These can be used to determine the risk of a trade or an overall portfolio.

Alpha (the measure of excess return on an investment relative to a benchmark index, such as the S&P 500) and Beta (a measure of a stock’s volatility in relation to the market) are used in the context of stocks, so options trading begins with Delta.

Delta is the measure of how much an option’s price changes for a $1 move in the underlying asset. Call Delta is on a scale between zero and one. Put Delta is on a scale from zero to negative one. A Delta of 0.50 means the call price will increase by $0.50 for every $1 increase in the price of the underlying stock. For a put, -0.50 means the put price will increase by $0.50 for every $1 decrease in the price of the underlying stock.

Gamma measures the rate of change in delta as the underlying price changes. Delta is kind of like the speed of a car – the rate of change. Gamma is like the acceleration of the car – the rate of change of the rate of change. If a call option has a delta of 0.60 and a gamma of 0.05, a $1 increase in the underlying asset’s price would increase the delta to 0.65 (0.60 + 0.05). Conversely, a $1 decrease would decrease the delta to 0.55 (0.60 - 0.05). Options with higher gamma are more sensitive to price changes, and consequently, their deltas can change more rapidly.

Theta measures an option’s sensitivity to the passage of time. It quantifies the rate at which an option loses value, or decays, as it approaches its expiration date. This phenomenon is commonly known as time decay. Theta helps traders anticipate how an option’s value will erode over time, informing strategies for timing market entries and exits and managing risk effectively.

Vega is directly related to implied volatility (IV). IV reflects the market’s expectations of future price fluctuations in the underlying asset. Higher IV suggests greater price uncertainty and generally leads to higher option premiums, while lower IV implies less uncertainty and lower premiums. A higher vega means the option’s price is more sensitive to changes in IV. For example, if an option has a vega of 0.20, a 1% increase in IV will increase the option’s price by $0.20 per share (and vice versa for a decrease in IV). This can have a significant impact on an option’s value, especially for longer-dated options or those near the money.

How Options Prices Are Determined

Ultimately, like anything sold in an open marketplace, the price of an option is simply the level at which a seller is willing to sell and a buyer is willing to buy. There are a number of factors those buyers and sellers use to determine the price of an options contract, or premium.

Price of the underlying asset. The option’s price is directly related to the price of the asset it is based on (the intrinsic value). For call options (right to buy), as the underlying price rises, the option’s value increases. For put options (right to sell), as the underlying price falls, the option’s value increases.

Strike price. The strike price is the price at which the option can be exercised. For call options, a lower strike price is generally more valuable as it allows buying the stock at a lower price. For put options, a higher strike price is generally more valuable as it allows selling the stock at a higher price.

Time to expiration. Options have expiration dates, and the longer the time until expiration, the greater the opportunity for the underlying asset to move in a favorable direction. This extra time adds to the option’s time value or extrinsic value. However, as the expiration date approaches, the option loses value due to time decay (theta decay).

Volatility. Volatility measures the degree to which an asset’s price fluctuates. Higher volatility generally increases option prices because there’s a greater chance of the option becoming profitable due to wider price swings. Implied volatility (IV) reflects the market’s expectation of future volatility and is a key factor in option pricing models.

Options Strategies

We’ve already discussed most of the basic options strategies – buying a call or put and selling a call or a put. We’ve also discussed covered calls and protective puts which are similar but in which the seller owns the underlying shares of stock to generate additional income or limit downside risk.

Another basic strategy is known as a Bull Call Spread in which you buy a call at the same time that you sell a call with a higher strike price. The premium from selling the call reduces your risk but this strategy also limits your upside since if the price rises too much, the buyer of your call will exercise their right to purchase the shares. The following payoff diagram illustrates this strategy, assuming a premium of $1.50 for the higher priced call.

And where there’s a Bull, there’s a Bear.

A Bear Call Spread is similar but inverse of the bull spread and is appropriate when you have a bearish to neutral outlook and want a defined payoff with limited risk. The following diagram shows the payoff for selling a call at $100 for a $4.50 premium and buying a call for a $1.50 premium.

That’s not all there is though. Next up are some of the most common advanced trading strategies. There are many variations on these which we will not go into as they can be overwhelming.

Advanced Options Strategies

If you’re just getting started with options, you may want to skim or skip over all of these advanced trading strategies until you have some experience with basic trades. That’s not just my recommendation. Brokerages use options approval levels which are risk-based permission tiers that brokerages use to regulate which types of options strategies a customer is allowed to trade. These levels are designed to match an investor’s experience, financial situation, and risk tolerance with appropriate strategies, helping to manage the risks of options trading.

This approval system prevents you from executing certain kinds of trades until you are approved as a way to control your risk and prevent inexperienced investors from engaging in high-risk strategies they may not fully understand. While naming and exact structure can vary slightly by broker (e.g., Fidelity, Schwab, Robinhood), most follow a 4-level system like this:

To get approved for a level you generally need to complete an application that provides information on your trading experience, knowledge level, investment objectives, your personal financials, and your margin account status.

Now you know.So, let’s look at some of the more common advanced strategies.

Iron Condor. For this, you sell an out-of-the-money put spread and call spread – 4 separate trades. This strategy profits when the underlying price stays between the short strikes ($180–$200), offering limited risk and reward.

Butterfly Spread. This combines bull and bear spreads to generate profit from low volatility and a specific price target. It’s a good strategy when you expect the stock to stay near a specific price at expiration. In the example below, that price is $180, which is what produces the greatest profit. In the example below you buy 1 call at $170 for $1.50, buy 1 call at $190 for $1.50, and sell 2 calls at $180 for $4.50.

Straddle. This is somewhat the inverse of the Butterfly Call Spread above in that it’s something you would do if you think the stock is going to make a large move up or down. With a straddle you buy a call and put at the same strike and as you can see in the payoff diagram below, you profit from large price movements in either direction, the bigger the better.

Strangle. The strangle is a variant of the straddle in which you buy an out-of-the-money call and put. Similar to a straddle, but requires larger price movement. The example in the payoff diagram below shows buying a put at $175 for $4.50 and buying a call at $185 for $4.50 for a total cost (and maximum loss) of $9.00. A strangle is less expensive than a straddle but requires a bigger movement to pay off.

Calendar Spread. As the name suggests, this strategy makes use of different timeframes by selling a near-term option and buying a longer-term option. In the example below we buy 1 long-dated call (LEAP) at $180 for $6.50 and sell 1 short-dated call at $180 for $4.50. The maximum loss is the difference between those premiums, or $2. Your maximum profit is at the $180 strike price at the short option’s expiration. This strategy is ideal when you expect minimal price movement in the short term but want to profit from longer-term volatility.

Again, this is not a comprehensive list. There are a large number of strategies and variations on those strategies. I have tried to give you some of the more common strategies to give you an idea of the range of approaches.

Options Trading Platforms

When choosing a broker your research should include the fees, platform features, and research tools. While the base commission is now zero for many brokers, even on options trades, there are still options contract fees that typically fall in the $0.50-$0.65 range. You will also encounter or exercise fees and if you are trading on margin check out what the interest rate is. In addition, conditions in the options market can change quickly so compare the speed of executing orders.

A robust set of tools will help you find, evaluate, and execute trades quickly and efficiently. The following are some of the features to look for in your trading platform:

• Strategy builders help you pick the best trading strategy for a situation
• Payoff diagrams for trades you are considering
• Charts of implied volatility
• Greeks visualization charts
• Tools to assess probability
• Order entry that can handle multiple leg orders

When it comes to trading options, not all brokerages are created equally. Check for robust options trading capabilities and education. In addition to webinars, video tutorials, and articles, you will want something to scan for trade ideas and that enables you to look back at historical volatility and backtest strategies. And, they should have a paper trading (simulation) tool you can use to practice before you start trading real money.

You will find a comparison chart of the major options brokerages at the end of this article as well as a recommendation for which is the best match for you, depending on your preferences.

Options Trading Mistakes to Avoid

Don’t trade for the sake of trading. Stick to your strategy and risk management plan. Traders that get caught up in the thrill of the hunt generally get sloppy, cutting important corners and taking on greater risk. If you are trying out something new, use the simulation tool first until you have confidence and experience enough to go live.

Another classic mistake that traders make is charging into a trade without a plan for exit. Know what your profit targets and stop-loss levels are before you execute the trade.

Just as diversification is important in equity investing, it is in options trading too. Don’t get stuck on one strategy or one underlying stock. Using a variety of strategies and trading a variety of underlying stocks will help you learn more as well as spread out your risk if a company or sector encounters unforeseen barriers.

Tips for Trading Options

Options trading offers unique opportunities, particularly by introducing the benefit of leverage into your investing. That same leverage also means risks (you didn’t think you were going to get something for nothing, did you?) if you aren’t careful, especially if you trade on margin.

Mastering the basics—calls, puts, the Greeks, and key strategies—lays a strong foundation for you to take advantage of the opportunity options trading provides. Continue your education, practice with paper trading, and always focus on risk management.

Start on paper (simulation) then with small positions, stay disciplined, and let experience be your guide as you build skill and confidence in the exciting and dynamic world of options trading.

Understanding all of this should help you overcome any hesitation you may have with trading options because it seems mysterious. For many traders that’s all they need to get started. If you want a partner standing with you to guide you to profitable opportunities and give you the confidence to be a more successful trader, I have two words for you – Jacob Mintz. Jacob Mintz is a veteran options trader, a former CBOE market maker, and the smartest options trader I have ever met. His proprietary trading system is brilliant and leverages the research and analysis of the big “smart” money traders.

Jacob personally runs four services at Cabot. Cabot Profit Booster picks one momentum stock each week and adds a covered call as a way to increase yield. This is also a good starter for those who are new to options trading.

His Cabot Options Trader, Cabot Options Trader Essentials, and Cabot Options Trader Pro services make use of his full proprietary system, with the pro version offering advanced trading strategies. (He is also the brains behind Jacob’s Private Circle which is an invitation-only service dealing with lower-liquidity options, so membership is very limited.)

Options Broker Comparison Chart

Which Broker is Right for You