Strategies for Managing Your American Option Investments

American options are different from European options in that American options can be exercised at any point prior to expiration, while European options can only be exercised on the expiration date. European options often have indexes as their underlying investments. American options tend be used more for stocks and bonds. They also have different expiration dates. Since American markets are closed on weekends, they expire on the third Friday of every month. American options expire on the day after, on Saturday.

Basics

An call option allows you to buy a stock at a certain price, and a put option allows you to sell the stock at a certain price. You have several strategies to consider when buying options. You might want to hold the option until the expiration date. You might want to exercise it before the expiration date. Or, you might want to sell the option before it expires, in order to recoup any losses you foresee. Just like with other investments, a conservative investment strategy is more likely to yield consistent returns. An aggressive strategy might yield more money, buy you might also lose a lot of money very quickly.

Leverage and Diversification

American  options can be exercised before the expiration date. If they are not exercised before then, they expire without any value. Options can be used to leverage their investments. This is because you can purchase an option for a small fraction of the price of buying the entire stock. They can also buy options for more stocks than they can for the same amount of funds than if they were just buying stocks. This is a form of diversification.
Bullish Trading Strategies

If you expect a stock to go up, you will want to employ a bullish strategy. The most simple  bullish strategy is to buy calls. You can also  set a target price for the bull run and use any bull spreads to reduce your costs.
Bearish Trading Strategies

The most bearish strategy is simply to buy puts. Bearish strategies are mirror images of bullish ones. Another bearish strategy is to set a target price for the decline and use bear spreads to reduce your costs.
Neutral Strategies

There are a number of strategies you can use if you have no opinion whether the stock will go up or down.

  • Gut - You sell an in the money put and an in the money call
  • Condor - Sell a call that is out of the money.  Buy a call with a higher strike price. Sell an out of the money put. Buy a put with a lower strike price.
  • Butterfly - Buy a call that is at the money, and another that is out of the money. Sell two calls that are in the money.
  • Strangle - Buy an out of the money put. Then buy sell an out of the money call.  Make sure both options have the same expiration date.
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