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Complex Strategies Are Not Always Better Strategies

Posted April 23, 2012

Topics: Finance & Investing

Even the most experienced option trader can benefit with an occasional reminder: The most basic strategies often are the best, all depending on the situation and what you hope to accomplish with the option position.

Just mastering a complex strategy does not include the requirement that you abandon the basic ones that might work better. For example, do the conditions can for a long call or put, a covered call, or an insurance put? Admittedly, these are not the most exciting options strategies, but they do fit the bill in many cases.

Even swing and day traders may rely heavily on soon-to-expire ATM long options as an alternative to long or short stock positions. Why? The long options are cheap in their last two to four weeks, meaning your risks are lower than other swing trading strategies. You can play the top of the market with a long put, which is by far safer than shorting stock. And because options are much cheaper than stock, a single option -- controlling 100 shares of the underlying -- enables you to diversify a swing trading portfolio.

Analysis of other simple strategies reveal similar rationale. Many object to the covered call because if the underlying falls below the adjusted basis, it creates a loss. But the alternative -- owning 100 shares of stock -- involves moving into that paper loss realm much sooner, so what's the flaw with the covered call? Others point out that when the stock rises above the strike, stock is called away at market value below current price. But the trade-off is between a sure thing in the form of option premium versus the occasional lost opportunity. You can also roll forward or forward-and-up to defer exercise and create additional profits if and when the call is exercised.

The insurance put might be a wise alternative to selling stock you would rather keep. Dips in price have to be expected, but the traditional response - taking profits before they turn into losses or mitigating an existing loss - is not always desirable. The insurance put limits or stops the paper loss and helps you to hold onto shares that you believe will appreciate over time.

In other words, these basic "oldies but goodies" work best in so many circumstances, that the more exotic and complex alternatives are not always better.