Options trading can be somewhat of a mysterious and intimidating topic. Unlike traditional equities or even ETF’s, options contain a large amount of additional metrics and information that can further complicate the picture, especially for the untrained eye. In addition, there are potentially hundreds of options to select from on any given stock! So why is there so much buzz around options trading?
Options present a unique potential benefit to the end user that relates back to leverage. Each contract represents 100 shares of stock, meaning the trader experiences higher risk-to-reward ratios with smaller outlays of cash than buying the actual stock. While this means there is greater potential upside, there is also greater potential risk, so it’s very important for the trader to understand the dynamics of the trade before they hit ‘execute’. Options can be played on both sides of the market, in the form of calls (options that profit when the stock goes up) and puts (options that profit when the stock goes down).
Now that we’ve gone through some of the basics, let’s jump into spreads. An options spread is a trading strategy that combines multiple options to create a defined payoff structure – for example, $50 to make $50, or $100 to make $200. However, they do require specific expertise to put on – which is where the Optionality app comes in. Optionality offers an app-based trading platform that displays a menu of potential options spreads to choose from, organized by risk (low, medium, high) and time to expiration.Let’s take a look at five potential benefits of options spreads and why someone might want to trade them:
Options spreads involve the buying and selling of two options to create a closed position. This means that the price to enter into an options trade for many spreads are fractions of what it costs to enter single calls or puts. Many of the trades on Optionality only cost between $25 and $75 to enter!
2. Lower Breakeven
Because the price is lower to enter the position than a single call or put, the breakeven point – the price at which the positions will start to turn a profit – is much lower. This means that, over time, more options spreads will finish profitable than single calls or puts.
3. Defined Outcomes / More Transparency
Options spreads have defined outcomes on both sides of the trade. Your maximum loss is equal to what you pay to get into the position*, and you know your maximum gain on the position. This helps frame potential outcomes and may lead to better decision making.
4. Less Exposure to Volatility (and other Greeks!)
Volatility, delta, theta, gamma… these difficult to grasp options concepts can significantly affect the price and profitability of options. Because spreads contain both long and short options, there is a significant offset to these factors, meaning there is less impact to your trades.5. Ability to Trade Either Side of the Market
Options spreads can be profitable if the market is going up or down. Whether you think the market is overpriced or undervalued, you can trade your opinion just as easily, without the same risks as shorting a stock.*there are rare scenarios where options spreads can ultimately result in a loss higher than the cost to enter the position. Optionality has automated processes to help ensure that this doesn’t happen, but in the market there are no guarantees!.