Sideways Strategies for Options Trading Market

Options trading is a great market in which traders can hone their skills. However, it does have a bad reputation–many investors believe that the market is a minefield of risk, and there are limited ways to trade safely. Despite this, the market continues to boom, and options trading has consistently remained one of the most popular trades amongst both professionals and retail traders.

Options Trading Market

If you are looking to get into options trading yourself, sideways strategies are a great way to dip your toes into trading. It is also good practice for technical analysts to train themselves and learn more about price patterns.

What are sideways strategies?

A sideways strategy is a low-risk options strategy that has the potential to yield high rewards. Investors use sideways strategies when they want to trade a stock with lower volatility. They include

  • The butterfly
  • The condor

Key terminology

Before moving on to go through the sideways strategies, it is vital that options traders understand a few key terms that will feature heavily in the article. If you regularly trade options, you may already be familiar with some of these terms. Nevertheless, let us go through them.

Options moneyness

In options trading, moneyness is used to describe the intrinsic value of an option. There are three types:

  • In the money options
  • Out of the money options
  • At the money options

In the Money (ITM)

In the money options is an options trading that has an intrinsic value greater than zero. A trader with an ITM option that chooses to exercise it would gain a net cash positive for immediately selling the underlying stock to offset their action.

An ITM call option refers to the market price being higher than the strike price of the call option purchased. An ITM put option refers to the market price being lower than the strike price of the put option. In either case, it is a good idea to exercise ITM options trading.

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Out of the Money (OTM)

Out of the money options are options trading that has no intrinsic value. They are essentially the opposite of ITM options. OTM call options have a higher strike price than the market value of the underlying asset, while OTM put options have a lower strike price than the market value. It is not a good idea, generally, to exercise OTM options.

At the Money (ATM)

At the money options are options that have a strike price that is roughly equal to the current market price of the underlying asset. They are sitting right on the fence, and at any moment could topple over to either side and become ITM or OTM options. Investors must keep a close eye on ATM options, which puts traders in a rather interesting position.

The butterfly

The butterfly is the first sideways strategy for options trading we will examine. It includes using all calls or all puts, but not a mix of the two.

Using the butterfly with calls

Retail traders can use the butterfly with calls when they first buy one lower strike ITM call, sell two middle strike ATM calls, and finally buy one higher strike OTM call.

Using the butterfly with puts

Retail traders can use the butterfly with puts when they first buy one lower strike OTM put, sell two middle strike ATM puts, and buy one higher strike ITM put.

Tip

In real-world scenarios, it will be difficult to be too ambitious with your entry price if you want your order to be filled. In this case, you should always find the overall price you would be happy to make the trade at. To do this, you can first calculate your reward and breakeven scenarios as well as your risk level.

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Identifying a butterfly

Now that you know what a butterfly is and how you can use it, it is important to learn to identify opportunities that arise in the market. Some things you can look at are the

  • Rangebound stock pattern
  • Stock price
  • Implied and historical volatility of the asset price

To identify a butterfly, you should find clear lines of support and resistance. You should make sure these lines are firm and you have a level of certainty that the price will remain within the bounds for a period. When you identify a price pattern, you may find a narrow or a wide butterfly.

A wider butterfly pattern will have a lower maximum reward, but it will have a higher probability of profit. On the other hand, a narrower butterfly will have a higher maximum reward, but a lower probability of profit.

Trading the butterfly

When you are ready to trade the butterfly, you should make sure that you have a clean entry. You should not be anticipating more news that will come. Ideally, you should enter the market just as news on the stock or asset has just passed.

If you are trading stock options, this might mean earnings reports or quarterly announcements. You should select an options trading that has a far enough expiration date.

If you choose one that is too close–anything under one month–you will be faced with a greater risk. However, be sensible and do not choose an expiration date that is too far away, or the opportunity will have passed before you exercise the option.

A generally recommended timeframe is between one and two months, but it is dependent on the shape of your butterfly. You can exit your trade the closer the price point is without breaching the wings of the butterfly pattern.

The condor

The condor is the second sideways strategy for options trading we will examine. It includes using all calls or all puts, but not a mix of the two.

Using the condor with calls

Retail traders can use the condor with calls when they first buy one lower strike ITM call, sell one lower middle strike ITM call, sell one higher middle strike OTM call, and finally, buy one higher strike OTM call.

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Using the condor with puts

Retail traders can use the condor with puts when they first buy one lower strike OTM put, sell one lower middle strike OTM put, sell one higher middle strike ITM put, and finally, buy one higher strike ITM put.

Identifying and trading condor

Now that you know what a condor is and how you can use it, it is important to learn to identify opportunities that arise in the market. Like the butterfly, some things you can look at are the;

  • Rangebound stock pattern
  • Stock price, and
  • Implied and historical volatility of the asset price

When you are ready to trade the condor, you should likewise make sure that you have a clean entry. Even though the condor can only yield a limited profit (when the price hits between the two middle strike prices), there is some flexibility as there are two breakeven points in this price pattern.

Conclusion

There are a few differences between the butterfly and the condor. Generally speaking, the butterfly is an easier trade to place because it has fewer ‘legs’ compared to the condor, which has four.

It is also less expensive to trade, and traders are likely to have an easier time finding the optimum strike price. However, both sideways strategies for options trading are relatively low risk, so it does come down to personal preferences and market direction.

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