Algorithm-based trading software makes it easier for traders to trade in various market segments. You can choose from predefined strategies and trading styles based on the market conditions and your risk profile. Algo trading has not only become popular in the financial markets but is also becoming the need of traders in the volatile market.

Trading in derivatives market is more complicated and risky in terms of choosing the right strategy as per the changing market conditions or change of sentiments of investors towards a particular stock. But Algo is making it easier with more user-friendly interface to choose the right trading strategy as per your available funds and risk-bearing capability.

In the derivatives market, trading in options you have wide options to choose the trading strategy that can work as per the trend in the market and your expectations. Here we are going to share with you useful tips or techniques for choosing the algorithmic options trading strategies.

What is Algo Trading?

Before we proceed, we need to rewind our concept towards Algo trading. This is an automated trading solution developed based on computer-based algorithms to make trade decisions as per the changing market conditions and trends in the stocks.

It can execute multiple types of transactions at a time at a very high frequency with the capability to generate a huge volume of trades at high efficiency and accuracy. Algo trading can make decisions based on mathematical tools and complex formulas combined with techniques along with human insight and makethe final decisions to choose the best strategy.

Things to Consider While Choosing the Options Strategies in Algo Trading:

Right Methodology

Before you choose or implement the option trading strategy you should have the knowledge of the strategy. You must be aware of how the strategy will work, its risk and reward potential in various market situations and is it suitable right now as per the market trend.

You can choose from popular option strategies like momentum-based, mean reverting, directional or market-neutral. You should be confident the strategy has the ability toperform positively as per your expectations even in unexpected market conditions.

Also Read: How to Identify Momentum Stocks for Intraday Trading: 8 Tips

Market Trend

Sailing with the flow of tides makes journey easier, likewise before choosing the option trading strategy, you need to be aware of the direction of the trend, whether it’s bullish, bearish or sideways. Based on the latest market trend choosing the right trading strategy will have the higher chances to give the returns.

Also Read: How to Identify Trend in Stock Market: 10 Points to Find Trend

You can implement technical analysis on chart patterns to get important levels as per the prevailing trend and thereafter, define your trading strategy. Trader who trade in option strategies, can make number of option strategies as per his risk, profit expectation, capital and market trend. In Algo software, you need to select the strategy and activate the same.

Also Read: Best Candlestick Patterns for Day Trading and Option Trading

Volatility Factor

Volatility level or rate of change of price of underlying is one of the important factors in option trading while choosing the right trading strategy. When the market/underlying is trading volatile, the option premium will become expensive for buyers and vice-versa. However, a volatile market condition in options creates more trading opportunities.

You can check the historical volatility and implied volatility levels if they tend to rise or decrease the trading strategy needs to be tuned accordingly. There are certain trading strategies that work well when volatility is high and there are also various trading strategies that work well volatility level is low. You can also use a combination of strategies.

Also Read: How to Trade in High Volatile Market: Best Trading Strategies

Use of Leverage

Trading in the high-risk option you need more amount of leverage to offset your trade position in unfavourable market conditions. When the market is highly volatile, the margin calls will be also high, hence trading in the high-risk trades you have to deposit the high margin of money into your broker's account which can cost you more reducing your ROI.

However, the leverage is decided as per the volatility in the market or individual stock and the amount of risk exposure you are ready to take. Based on the market movement and volatility you have to choose the right option strategy that requires a balanced leverage. The use of leveraging in trading in an optimum way helps to improve the rate of returns.

Frequency of Trades

In Algo trading, you can perform high-frequency trading by choosing the right option strategy that enters and exits into trade positions very often. But to trade in the high-frequency trading strategies in option trading you need more expertise and knowledge, as such strategies are more complicated and difficult to implement every time.

But in Algo trading software you can choose the high-frequency trading option strategies with the conditions to modify the strategy as per the change in market conditions. Moreover, high-frequency trading will also increase your cost of trading charges which can impact your overall returns. Hence choose the strategy wisely as per your risk profile.

Risk & Rewards

Gaugingtherisk and reward ratio in the Algo-based option trading is also very important to set the targets for profit booking and set the stop-losses for exiting the trade positions. Hence, it is very important to know for how much of return you are ready to lose how much of money. However, most of the option strategies are high-risk trading strategies.

And based on your risk-bearing capability and rewards expectations you can choose from various option trading strategies. If you are a high-risk trader you can go with a high-risk trading strategy, while for low-risk traders, low-risk option strategies are also available in Algo trading software, it totally depends on you to choose the right strategy.

Also Read: Types of Risks Associated with Investing in the Stock Market

Top Algorithmic Options Trading Strategies

After knowing about the important things that need to be considered while choosing the right strategy for options trading now you need to know about the popular strategies that can be used for options trading through Algo-based software. Here below we have discussed algorithmic options trading strategies that you can choose for trading.

Direction Based Strategies

In the directional-based strategies, the direction of the underlying security is predicted and based on the movement you have to pick the strategy. In option trading for direction-based strategies, you can choose Trend Following or Mean Reverting strategies.

However, subject to Implied Volatility (IV) of the underlying security and based on the direction you can also use simple strategies like plain vanilla Calls or Puts or four Vertical Spreads. These trading strategies are low-probability trades but can give high returns. However, Algo trading can also help to choose the strategy as per the direction.

Non-Direction Based Strategies

When the market is range-bound or trading sideways without any direction, you can choose the non-directional strategies. In range-bound trading strategies you can earn the profit whether the underlying security goes up or down or moves sideway within the expected range.

Also Read: Best Option Strategies for Sideways or Range Bound Market

These non-directional strategies in options trading are also known as high-probability trades as it has a higher probability of success but profit potential is less compared to directional-based trading strategies. For option trading non-directional market, you can choose from popular strategies like Short Strangle, Short Straddles, Butterflies and Iron Condors.

Volatility-Based Trading Strategies

When the market is highly volatile or the stock is trading with unidirectional ups and downs movement, you need to choose the volatility-based strategies in options Algo trading strategies. You can choose Long Strangles, Long Straddles, Short Condor or Short Butterfly that works in highly volatile market conditions, especially after a sustained contraction.

Also Read: How to Use Implied Volatility in Options Trading: Strategies

On the other hand, you can also use an implied volatility skew-based trading strategy in which you have to observe when option prices for different strike prices within the same expiration date don't have the same implied volatility (IV). Here you can take the trading opportunity to take the advantages of volatility skew and bet on reversion to the mean.

Market-Making-Based Trading Strategy

In Algotrading market making, is one of the most interesting but at the same time also very challenging trading strategies that you can also use for option trading. The market makers in the option market quote bid and ask prices for various contracts. This widespread bid-and-ask quotation helps understand the depth of the market andmaintain the liquidity in the options market.

Also Read: How to Use Market Depth for Intraday Trading Strategy

In such trading strategies, you can earn from the bid-ask spread and take advantage of movements in the market. However, the risks in this strategy are inventory risk and speed of execution, but Algo trading software is also known for high-frequency trading with high-speed transactions to generate huge trade volume at the best accuracy.

Delta Hedging Trading Strategy

In Algo trading for options, you can also use the hedging-based trading strategy. Delta Hedge is one of them is a type of risk management option strategy to minimize the impact of risk or offset the unexpected direction-based risk in the price movement of the underlying security.

Also Read: How to Manage or Do Risk Management in Options Trading

Delta is part of option Greeks used to measure the change in the price of option premium with respect to every point of change in the price of the underlying security. The value of the delta can affect the calls and put options in different ways based on strike prices.

Also Read: What are the Delta, Gamma, Theta and Vega in Option Trading

Hence, when you canimplement this delta hedging-based strategy in Algo, your trade position is hedged against thefluctuations in the movement of the price or Implied Volatility (IV) in the underlying security by entering into the offset position that is opposed to option Greeks.

Summing-up

Options trading is risky but can give you higher returns in a shorter period compared to conventional delivery-based trading in the stock market. Now Algorithm trading software option has become popular due to the implementation of a wide range of trading strategies that you can choose as per the market conditions and changes in the price trend.

But just like manual trading in options, you need to consider a few things in mind like choosing the right methodology as per the market trend while considering the volatility factor. You also need to consider the risks and rewards to use the right leverage to take advantage of high-frequency trading to make the option strategies successfully implemented in the Algo.

Also Read: Best Algo Trading Platform and Trading Strategies

And while choosing the right option strategy you have multiple options as if choosing the direction or non-direction-based trading strategy. In a highly volatile market conditions you can use the implied volatility-based trading strategy or go with a hedging-based strategy to offset your trade positions from unexpected movement in the underlying security.

Also Read: How to Start Algo Trading in Moneysukh: A Best Algo Trading Platform