Selling covered calls and cash secured puts is by far the most profitable way to trade options. When it comes to selling options in the stock market, there are various techniques that traders and investors can use. These include:
- Covered call: This involves selling call options on stocks that you already own, with the goal of earning income from the options premium. The strategy is considered “covered” because you have already purchased the underlying stock, which protects you in case the stock price rises and the option is exercised.
- Naked put Options: The strategy requires selling put options on stocks that you do not own, with the expectation that the stock price will not dip below the strike price, rendering the option worthless. However, this strategy is considerably riskier since you may be obligated to purchase the stock at the strike price in case the option is executed.
- Bear put spread: This a modified and hedged version of naked put, where you sell a put option with a lower strike price and buy a put option with a higher strike price. By doing so, this creates a “spread” between the two, and you can profit from the difference between the two options if the stock price stays above the higher strike price.
- Bull call spread: In Bull call spreads you are purchasing a call option with a lower strike price and simultaneously selling a call option with a higher strike price. This creates a spread between the two options, and if the stock price remains below the higher strike price, one can potentially earn a profit from the difference between the premiums received for selling the higher-strike call and the premium paid for buying the lower-strike call.
It is crucial to understand the risks and potential rewards of each of these options-selling strategies, as well as the market conditions and underlying stocks. Seeking advice from a financial advisor or professional money manager may also be helpful.
Selling Covered Calls:
How to Sell Covered Calls? Selling covered calls can be very profitable and a key tool for your long term investment strategy.
Here’s an example of selling covered calls:
For example let’s say that you own 100 shares of Tesla, which is currently trading at $500 per share. You believe that the stock is unlikely to rise significantly in the near term, so you decide to sell a call option on your 100 shares.
You sells a call option with a strike price of $550 that expires in three months, receiving a premium of $2 per share, or $200 in total, from the option buyer.
By selling this call option, you have agreed to sell your 100 shares of Tesla at $550 per share if the option buyer decides to exercise their right to buy the shares before the expiration date.
If the price of Tesla stock remains below the $550 strike price, the option will expire worthless, and you keep the $200 premium payment as profit. If the price of Tesla stock rises above the $550 strike price and the option buyer decides to exercise their right to buy the shares, you will sell your shares at $550 per share, realizing a profit of $50 per share plus the $2 premium payment, for a total profit of $5200 ($5000 in stock appreciation + $200 in premium payment).
Selling covered calls is a great way to generate additional income from the stocks you are holding, but it’s essential to understand the potential risks and rewards of the strategy before engaging in it.
How to Sell Cash Secured Puts (CSP): Example
If you want to buy a stock, what if there was a strategy that allows you get premium while you are waiting for your target price. Here is how cash secured puts works
Let’s say you’re interested in buying 100 shares of Google stock which is trading today at $50 per share, but you believe the stock is currently overvalued. You could sell a cash-secured put option which expire in 1 month from today at strike price of 40, which would give someone else the right to sell you 100 shares of Google at $90 per share at he end of expiry, if Google stock price is below 90 at that day.
For this example, let’s say the current market price of Google stock is $50 per share, and you think it’s a good buy at $40 per share. You could sell a put option with a strike price of $40 and a expiration date of one month from now. Let’s assume you receive a premium of $100 for selling this put option.
If the price of the stock stays above $40 until the expiration date, the option will expire worthless, and you will keep the $100 premium. However, if the price of the stock falls below $40 and the option is exercised, you will be required to buy 100 shares of Google stock at $40 per share, regardless of the current market price.
Depending on which broker you use, you would need to have enough cash on hand to buy 100 shares of Google at $40 per share. If you end up buying the stock, you will have spent $4,000 to buy the shares, but you will have also received the $100 premium, reducing your net cost to $4,400. And if Google stock stays above $40 per share, your collateral will be released and you can keep your $100.