What is the Directional Trading Strategies Template?
The directional trading strategies template helps investors determine the profit of different options strategies. The template includes four strategies: Bull calls, bull puts, bear calls, and bear puts. The template shows the profit of the strategy depending on the spot price relative to the strike prices. Numbers of strike prices, net premiums, and spot price can all be altered.
Here is a quick preview of CFI’s directional trading strategies template.
Bull calls are bets that the underlying asset will increase in price. Investors create this by buying a call option with a lower strike price and sell a call option with a higher strike price. Cost of options differs depending on the strike price due to the premiums. The premium is higher for call options with a low strike price because they offer greater value.
Since buying a call option can be expensive, investors can choose to sell a call option with a higher strike price. By doing so, investors collect a premium that slightly offsets they premium they paid. By doing this, they create a bull call.
Investors use the bull put strategy when they believe the markets are good and prices will increase. It is similar to bull calls but uses put options instead. Investors can create bull puts by buying a put with a lower strike price and selling a put with a higher strike price. A bull put will have lower loses in comparison with a long put when prices fall. However, it also caps the earnings of the option. Thus, the cash flow is less volatile.
A bear call is based on the belief that market prices will fall. Investors or traders create this by selling a call with a low strike price and buying a call with a high strike price. Similar to other directional strategies, both the profit and loss is capped. However, this also means there is less volatility with the earnings. If prices end up increasing, an investor with a bear call will suffer fewer losses than an investor with a call option.
A bear put is also a bet that the price of the underlying asset will decrease. This strategy will create a profit when the market prices fall. Investors create bear puts by selling a put with a low strike price and buying a put with a high strike price. A bear put is cheaper than just buying a put option and decreases volatility.
Since an investor is selling a put option, they can collect a premium to offset the cost of buying a put option with a high strike price. Since a put option gives the buyer the ability to sell the underlying asset at a strike price, the option with a higher strike price is more valuable as it gives the buyer more income.
Why Does It Matter?
Directional trading strategies help investors limit their risk, decrease costs, and predict the cash flow with greater accuracy. Understanding directional strategies also help investors create more complex strategies. These strategies combine bull spreads and call spreads and bet on the volatility of the underlying asset.