Step-By-Step Guide to Selecting the Right Option Strategy

Finding the best options trading strategy for any given trade is not an easy task. You cannot simply set up a multi-legged strategy based on your emotional biases or impulsive decisions alone. You need to diligently factor in various aspects and have a clear action plan for selecting options strategies for your next trade. 

This article can help you understand how to select the right options trading techniques each time. 

A Step-by-step Guide to Selecting the Right Options Trading Strategy 

If you are keen on understanding how to select the right options trading strategy for your trades in the F&O market, the following steps and pointers can help you. 

• Decide on the Market Segment

The first thing you need to do is decide on the market segment in which you want to trade. This will determine the underlying asset for the options contracts you choose for your trade. They can be stocks, commodities or currencies. If you want to trade in the equity market, for instance, you need to be clear about which company’s shares you wish to trade in, so you can move on to the next step in selecting stock options trading strategies. 

• Assess Your Market View

Once you're clear about the market segment you want to be trading in, you need to assess your market outlook for that segment and asset. Do you think the asset's price will likely increase or decrease in the future? Do you think the asset's price will experience significant volatility before the option's expiry? Or do you expect a relatively stable and non-volatile price graph for the asset? These are the questions you need to answer next to find appropriate bullish, bearish or neutral options trading strategies. 

• Identify Your Trading Objectives

The next step is to understand your trading objectives. Different options strategies help you achieve different goals like maximising profits, minimising losses, hedging a position held in a different market and even speculating on price movements. Multi-legged options trading strategies can help you achieve more than one of these goals. So, once you know what you want to achieve from each trade, you can pick an options strategy accordingly.

• Consider Your Trading Timeframe

You also need to look into the timeframe for your trade. This is essentially the timeframe within which your expected market outlook may come to pass. This parameter is important because you need to choose options whose expiration dates align with the said timeline. If your options expire too early, the market movement you anticipate may not have occurred yet. On the other hand, if the options expire too late, the expected market outlook may have already occurred by the time you close your trade.

• Pick an Options Trading Strategy 

Once you have a clear idea of the market segment you want to trade in, the underlying asset, your market view, trading objectives and timelines, you can choose a strategy that aligns with these parameters. Different options trading techniques align with different goals and market views. Some work best if you expect a bullish move, while others are suitable for bearish markets. There are also many neutral options trading strategies to choose from.

• Evaluate its Risk-Reward Proposition 

Once you have chosen an options trading strategy, you need to shift the focus from external elements and look into aspects intrinsic to the trading technique. This means you must evaluate the risk-reward proposition of the strategy and assess the probability of profit and loss. You can also check the maximum gain or loss in different market scenarios to better identify if a strategy fits your risk-reward preferences. 

• Backtest and Simulate Before Execution 

If you want to make doubly sure that a particular strategy works best for you, you can backtest and simulate the technique to see how it holds out in real market conditions. Backtesting involves using historical price data to implement an options trading strategy and assess the possible outcomes. While it's not always a guarantee that future price movements will yield the same results, it helps you understand how the strategy could work more clearly. 

Conclusion

The steps outlined above can help you find options trading strategies for different market outlooks and with different goals like profit maximisation or loss reduction. That said, manually choosing strategies for each trade can become time-consuming and prone to errors.

The Motilal Oswal Research 360 platform offers a better alternative — with its inbuilt options strategy builder. Using this feature, you can find, build and save options trading techniques for your trades based on different market outlooks like bullish, bearish, neutral volatile and neutral non-volatile. Sign up on this platform today to make options trading strategy building easier.