Let’s talk about writing options to generate income, i.e., selling put and call options. Writing options can be a great way to create a monthly cash income with a host of profitable benefits.
The first and most obvious of these advantages is that when you write (sell) an option, you collect an upfront premium. That means you get money up front for selling the right to either sell an underlying stock (puts) or buy the underlying stock (calls)
The fact that you collect a premium upfront leads us to the first of our four strategies for and benefits of writing options:
1) They Generate Income.
Selling either put or call options allows you to generate income from your current stock holdings. If you’re right about the direction of the stock you sell a put or call on, the best-case scenario is for the options you sell to expire worthless. When this happens, you get to keep the premium without having to act at all on the underlying stock. In essence, you’re collecting rent on the positions you own, and you don’t have to put a dime into the property (other than your original investment). This ability to generate income from existing holdings is perhaps the biggest benefit of writing options.
2) They Can Establish Long Positions.
Selling put options is a good way to get in on a stock that you wouldn’t mind owning if that stock falls to a predetermined price. For example, if you wanted to buy XYZ stock at $20 and it’s trading at $22, you could sell a $20 strike put, collect the premium, and wait for the stock to decline. If it doesn’t hit $20 before expiration, you keep the premium. If, however, the stock does fall, then you will be “put” the stock and you’ll own it anyway. In effect, you can get paid to wait for the stock to come down to the price you wanted to buy it at in the first place.
3) They Protect Your Gains.
If you own a stock and you’ve made some good gains with it, think about reducing risk in that position. One way to do this is to protect your gains by writing (selling) a call option on that position. If you write a call on a winning position and then the stock gets called away from you, you are forced to sell the call at that specified price — plus, you’ve already collected the premium. Yes, your potential long-term upside is capped if the stock keeps rising, but when it comes to trading, banking smaller, consistent gains is the real key to accumulating big trading profits. Writing calls allow you to protect your gains while also giving those gains a little extra juice.
4) They Provide Flexibility.
When you write an option, you have the flexibility to close your trade at any time. All you need to do to “get out” of the obligation you’ve auctioned off to either sell an underlying stock or buy the underlying stock is to buy back the option and effectively wash out the trade. The ability to basically cancel these contracts in the open market at virtually any time provides traders the kind of flexibility needed to make sure their holdings don’t get into hot water.
This article originally ran in Traders Reserve.