When it comes to trading Forex online, there are only limited number of strategies that you can use in order to maximise your returns. This is because there is 100% correlation between the CFDs that you trade and the asset in question.
However, when you use something like an option and particular options strategies then you can implement a range of different strategies that take advantage of the asymmetric pay-out structure of an option.
In this post we will go over some of the most profitable option trading strategies that you can implement to improve your returns.
What is an Option
Put simply, an option gives the holder the right but not the obligation to buy or sell an asset at some predetermined time in the future. The time in the future is called the expiry time of the option. The price at which the option can be bought is called the strike rate.
When the option confers the right to buy the asset that is called a call option. On the other hand, when the right is to sell the asset then this is called a put option.
In the case of a call option, the holder is in the hope that the price will expire above the strike. This is termed being “in-the-money” or ITM. The opposite can be said for a put option.
Options can also be written on a range of different assets from forex to commodities and equities. They were first introduced hundreds of years ago in rural Japan as a method of ensuring the right price for rice on the harvest.
What strategies Can you Implement
There are a range of different strategies that one can implement with a options. They have payoffs that have an unlimited upside and a limited downside.
These strategies usually involve more than one option and have interesting names that have been attributed to them. These have also been used to a great degree in investment banks and hedge funds on Wall Street.
Straddle Option Strategy
A straddle is a volatility maximisation trade. It is developed in order to take advantage of great volatility in the asset irrespective of the direction. It is constructed through the use of a long call can a long put option.
The straddle will usually have both of the options struck at the money and as such the payoff will look like a large “V”. If the price of the asset moves far above the strike the option will expire in the money. Similarly, if the price moves far below the strike then the option will also expire in the money.
If the price does not move that much from the current levels then the strategy will expire out of the money and the investor will lose the combined premium.
Strangle Option Strategy
A strangle is also an option strategy that tries to make use of great volatility in the price of the asset. However, unlike the straddle, the put and call option will be entered into with different strike prices.
This means that the payoff structure of the strategy won’t be a “V” but more like a “V” with an extended base. You can see an example of the payoff in the picture to the right.
This strategy will also aim for the same target as the straddle but it is usually quite a bit cheaper to implement. However, it will require a much larger move either up or down to expire in the money.
This is also another strategy that tries to make the most of an increase in volatility. The only difference between this and the strangle / straddle is that it tries to cheapen the strategy by capping the upside by entering two extra short positions.
The trader will short a call that is out of the money and will short a put that is out of the money. As you can see from the graph, the profit on the up and down side is capped with the Iron fly.
There so many option strategy that you can use to maximise your returns. These are only a few of them that can increase your returns from volatility maximisation.
In the coming posts we will go over more strategies that can greatly improve your chances of a successful trading record.