Options can cut both ways. If you don’t know what you’re doing, you can get destroyed and lose a lot of money.
Covered calls, for example, got me in big trouble back in 2000 when I wasn’t really using them the right way. I purchased a high-flying Internet stock for $143 per share, just so I could sell the covered call for $20 and earn $2,000 lickety-split.
I was enticed by that insane premium, which was normal at the time. Volatility creates high premiums, and Internet stocks were moving in double digits on a daily basis. Well, that company promptly tanked. Rather than eat the $2,000 loss I had by expiration (as the stock had fallen 40 points), I held it all the way down to $1.40. Trust me, the capital loss that would offset other gains for tax purposes was still a bitter pill.
Today, I will only sell covered calls against certain stocks.
In today’s case, I’m going after stocks that I believe are undervalued. You can buy the underlying stock, then sell the calls. You earn the premium, so if the stock doesn’t get called away, you make extra money. If it does, you can always buy back in at any time.