TradingKey - Advanced stock trading techniques involve a series of complex strategies that investors utilize to maximize returns in financial markets. These strategies are not only powerful tools for professional investors but also essential knowledge for aspiring traders aiming to achieve substantial returns.

Traditional stock market wisdom follows the “buy low, sell high” model,  where investors purchase stocks first and sell them later at a higher price to realize profits.

However, short-selling challenges this conventional approach by allowing investors to profit from declining stock prices.

Short-selling involves borrowing shares from a broker, selling them at the current market price, and later repurchasing them at a lower price to return to the lender—thereby profiting from the price difference.

What Risks Are Associated with Short Selling?

While short-selling can generate profits during price downturns, it carries significant risks:

Unlimited Loss Risk. 

Unlike traditional stock purchases, where losses are capped at the purchase price, short-sellers face theoretically unlimited losses if the stock price rises instead of falls.

Borrowing Costs. 

Short-selling involves borrowing shares, which incur fees or interest payable to the lenders or interest payable to the lender. If profits from short selling do not exceed these costs, investors may suffer losses.

Mandatory Buy-in Risk. 

Lenders may demand the return of borrowed shares at any time,  often due to market regulations or their own needs. This can force investors to buy back shares at unfavorable prices, even if the stock has not declined as expected.

Regulatory Risks.

 Regulatory authorities may impose restrictions or outright bans on short-selling during volatile market conditions, potentially disrupting trading strategies and forcing premature position closures.

Options are unique financial derivatives that grant investors the right -(but not the obligation)- to buy or sell an underlying asset (such as stocks, indices, futures, etc.) at a predetermined price within a specific period. The option premium is the cost of acquiring this right, paid by the option buyer to the seller. This functions similarly to an insurance premium, where the buyer secures the ability to execute the trade under favorable conditions while the seller assumes the risk in exchange for the premium.

What are the types of options trading?

• According to the exercise direction, options trading is categorized into call options (bullish options) and put options (bearish options).

A call option grants the buyer the right to purchase the underlying asset at the strike price in the future. Investors usually purchase call options when anticipating an upswing in the price of the underlying asset.

A put option gives the buyer the right to sell the underlying asset at the strike price in the future. This strategy is suitable for situations where investors anticipate anticipating a decline in the assets' price.

• Based on different exercise times, options can also be classified into American options and European options.

Holders of American options can exercise their rights at any time before the expiration date, providing greater flexibility.

Conversely, European options are exercisable solely on the expiration day.

Detailed Explanation of Common Options Trading Strategies

Long Call

Investors who expect a significant rise in a stock's price often buy call options.

For example, Suppose a stock is currently priced at 100 yuan per share, and an investor anticipates a price increase. The investor buys a call option with a strike price of 105 yuan at a premium of 5 yuan per share. If the stock price rises to 120 yuan before expiration, the investor exercises the option, buying at 105 yuan and selling at 120 yuan. After deducting the 5-yuan premium, the investor profits 10 yuan per share.

The advantage of this strategy is that the potential profit is unlimited; the higher the stock price rises, the greater the profit margin. The risk is that if the stock price does not rise but falls instead, the option will expire worthless, and the investor will lose the entire premium.

（Source: Wikipedia）

Long Put

Another strategy is buying put options, which is useful when investors anticipate a decline in a stock’s price.

Suppose a stock is currently priced at 80 yuan, and an investor expects it to drop. The investor buys a put option with a strike price of 75 yuan at a premium of 3 yuan per share. If the stock price drops to 70 yuan, the investor can sell the stock at the strike price of 75 yuan and buy it back at the market price of 70 yuan.

The advantage of this strategy is that the profit potential increases as the stock price declines. However, if the stock price rises instead, the option expires worthless, and the investor loses the premium.

（Source: Wikipedia）

Short Call

Investors who believe a stock’s price will remain stable or decline may choose to sell call options. The seller collects the option premium upfront, which serves as their primary source of income. However, this strategy carries significant risks. If the stock price rises sharply, the seller faces unlimited losses, as there is no cap on how high the stock price can go.

（Source: Wikipedia）

Short Put

This strategy is suited for investors who expect that a stock price will not drop significantly or may even rise or stabilize. The seller earns the option premium as income. If the stock price mains above the strike price at expiration, the put option buyer will not exercise the option, allowing the seller to keep the premium.

However, the risk lies in the potential for significant losses if the stock price declines substantially, as the seller's losses will be proportional to the decline in price.

（Source: Wikipedia）

Risks in Options Trading

• Leverage Risk: Options trading involves leverage, meaning that even small price movements can result in significant gains or losses. For example, purchasing call options requires only a small premium to control substantial underlying assets. If the asset's price rises, profits are magnified; however, if the price falls, losses also increase proportionally. To mitigate the risks associated with leverage, investors should manage their positions carefully, avoid excessive use of leverage, and adjust their investment sizes based on their risk tolerance. Additionally, diversifying investments across multiple options contracts or asset classes can further reduce the impact of volatility from a single contract.
• Liquidity Risk: Some options contracts have low trading activity, making it difficult to find counterparties or forcing traders to accept unfavorable prices, which can affect both trading and profitability.
• Market Risk: The value of options is influenced by various factors, including the price of the underlying asset, volatility, and interest rates. Price fluctuations in the underlying asset have the most direct impact, with increased volatility generally raising the option's value, while decreased volatility has the opposite effect. Changes in interest rates can also influence option pricing by affecting funding costs and the time value of the option.
• Time Value Risk: The value of options consists of both intrinsic value and time value, the latter of which diminishes as expiration approaches. Even if the underlying asset's price does not move as expected after purchase, the option's total value may decline due to the loss of time value.

Leverage in stock trading is a strategy that enables traders to control larger market positions than what their initial capital would typically allow.

How Does Leverage Work?

When using leverage, traders typically open a margin account with a broker, allowing them to borrow funds to purchase securities. For example, if a trader has $1,000 capital and uses a leverage ratio of 10:1, they can control $10,000 worth of stocks. The trader's capital serves as a deposit, while the broker provides the remaining funds needed to execute the larger transaction. While leverage can amplify potential gains, it also significantly increases the risk of substantial losses. Even a small decline in the value of the underlying asset can result in significant financial losses, potentially triggering a margin call, where the trader must deposit additional funds to maintain the position.

Key Points to Note in Leverage Trading Strategies

Choosing a Leverage Ratio

Risk-averse investors seeking stable returns should opt for a lower leverage ratio, such as 1:2 or 1:3, to minimize losses from market fluctuations. Investors with high risk tolerance who aim for higher returns and have a strong understanding of the market may consider ratios of 1:5 or 1:10 but must be prepared to face greater risks.

Cost Control

Leverage trading involves borrowing, incurring interest, and other fees directly affecting net investment returns. Before trading, investors should understand how their broker calculates interest and fees, as these can vary significantly between brokers. Selecting a broker with competitive fees can help reduce costs. Additionally, investors should assess the relationship between investment returns and costs, ensuring that potential returns not only cover cost expenses but also leave for profit.

Risk Management

It is also essential to regularly monitor and evaluate investment portfolios to adjust strategies in response to market changes. Effective risk management is essential in leveraged trading to prevent unmanageable losses. Investors should conduct thorough market research, incorporating both fundamental and technical analysis to improve the accuracy of their market trend predictions.

Beware of the Pitfalls of Leverage Trading

While leveraged trading can offer substantial gains, excessive leverage carries significant risks. Over-reliance on high-leverage ratios can lead to dramatically magnified losses if market trends move against investors. For example, with 10x leverage, a 10% drop in stock prices could wipe out the principal, and further declines may even result in the investor owing money to the broker. Moreover, excessive leverage can increase psychological stress, leading to impulsive trading decisions that further exacerbate losses. Therefore, investors must fully understand the risks of leverage trading, avoid over-reliance on high leverage, and implement effective risk management strategies for more cautious and disciplined investing.