Want to know the best way to make money with options? Selling put options that is. In this article, I will go over how you can use options to generate income and why every investor should know about options. I will also talk about how selling options plays an important role in your investment portfolio and why I even prefer selling options for income over collecting dividends. Before I talk about how we can benefit from selling options, it’s important to understand what they are and why we use them in the first place. Since this article is about using options to generate income, we will discuss options from a sellers perspective.
- 1 option represents 100 shares
- Every option contract has an expiry date and a strike price.
The easiest way to describe selling options is like selling insurance. When an insurance company sells you a policy to insure your car or any piece of property, you pay them a premium and they guarantee to cover the costs associated with the loss or damage of that property. That premium you pay is determined by the risk of loss or damage to that property. If you get into an accident and your car is totaled, the insurance company ends up owning the car.
Selling put options is like being in the insurance business. When you sell a put, the buyer of that put option pays you a premium and your broker account will be credited as soon as you enter the contract. Yes, you keep it. It’s yours! You are now in a contract where you agree to buy 100 shares of XYZ corp if it falls below a certain price(the strike price selected) after a certain date(the expiry date selected). The premium paid is determined by how likely it is that the share price will drop below the strike price that was set. This is why option premiums are higher for volatile tech stocks vs safer utility stocks.
On the flip side, you could also sell a call. So instead of being long 100 shares, you would be short 100 shares if the share price ended above the strike price after expiry date. This is very risky since your losses are infinite. I never sell calls unless I own 100 shares already and I plan on selling them. This is known as a “covered call” since your losses are capped in this situation. Using covered calls when you want to sell is a no brainer because you are essentially being paid to sell your shares at an agreed price. Of course, you must own 100 shares to do this. If it doesn’t reach the strike price, I keep the premium and the shares.
Make money with options selling put options?
I only sell puts against stocks I want to own. So i’m happy to get assigned 100 shares at a discount AND i’m happy because I was paid a premium to do it. If the price of the stock doesn’t drop to the strike price, I don’t get assigned 100 shares but I keep the premium and sell another put. I will repeat this process until I’m assigned another 100 shares. It really is a win-win no matter what the outcome is.
Now I can’t finish this article without talking about the drawbacks of selling puts. A major one being that if the stock takes off to the moon and doubles in price, you don’t benefit from those gains. Remember, you don’t actually own the stock but you’re being paid a premium from an option buyer that wants to protect himself from downside risk or is just speculating. So you get the premium and that’s it. Personally, I’m ok with this since in most cases im getting a better return consistently selling puts close to the strike price every month instead of buying 100 shares at market price. On average, I can get a fixed rate of return at around 10-12%. Not bad in a market with super low interest rates.