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2 Basic Ways to Sell Options for Income

Recently, we introduced 3 Easy Profitable Options Strategies that you can use to make money in a variety of different financial markets where buy options strategies can be employed. The bullish, bearish, and non-directional strategies mentioned involved buying options. This provides investors with the right, but not the obligation, to buy a given stock if the options contract lands in-the-money by expiration.

Today, we’re going to cover a couple ways to earn money from the markets by writing (i.e., selling) options contracts. These sell options strategies can be useful in their own ways to generate income.

In the first strategy, if you are looking to sell a stock you own provided it gets to a particular price, you can write an options contract to collect premium. If it does not get to that price, then you can hold on to your shares and make profit off the premium.

If it does get up to that price, then you still keep the premium and have the chance to sell your shares.

With respect to the second strategy, if you want to buy a particular stock (but the price is currently too high), you can make money by waiting for that stock to get down to your desired price.

In that case, writing options can truly be a win-win situation even if neither strategy necessarily guarantees profit (like all investments with the exception of perhaps arbitrage trading).

I will cover each of them individually more in-depth below:

1. Expecting a Stock to Fall in Price or Raise Just Slightly

In a market that you expect to be bearish, consolidate, or only moderately bullish, selling call options can be a great strategy to employ.

If you sell call options, that entails that the individual buying the contract has the right, but not the obligation, to buy 100 shares of the given stock for which the contract is written.

If the stock decreases in price, stays approximately the same, or goes up moderately, then you will earn the premium for this contract finishing out-of-the-money.

Sell Call Options Example

Let’s say your stock of interest is McDonald’s (MCD) and you don’t believe it’ll go above a price of 101. There is a recent resistance level just below 101 and also the psychological resistance at the 100 whole number. And let’s say you sell this call option while it’s trading at 97.

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You could collect a premium of around $6.00 on the contract ($600 total given there are 100 shares per contract).

If you are correct and the stock does stay below 101 by expiration, you keep this $600 premium. If you are wrong and this options lands mildly out-of-the-money, say 105, then you would still collect this $600 premium but lose $400 on the trade itself. (The contract is for 100 shares and the difference between the strike and closing price was 4.00, giving a loss of $400.)

Even so, you still gained $200 profit on this trade due to the amount of premium collected. Not only that, but when you sell a call option at a specific price, that is inherently saying that are inclined to sell your shares at that price. At 101, perhaps you feel MCD is priced beyond where you believe it should be or you’re simply okay with selling your shares at that price for a strong profit.

For each 1.00 that the option goes out of the money, you lose $100. But on the same token, you can close the position early to limit your losses or lock in a gain.

But with selling calls, you need to be content with the idea of having to sell your shares in the case of an out-of-the-money option. And by writing the options contract in the first place, you should be okay with the possibility given that if it does get to that level, you’re selling at a great price.

2. Believe a Stock Will Increase or Get In at a Great Price If It Doesn’t

If you believe that a stock will increase in price, or would be satisfied with getting into it at a lower price even if it doesn’t, then selling put options would be a great strategy to employ. This strategy is opposite of the first. You can make money if the market is bullish, consolidates, or even somewhat bearish. Like the last strategy, as the options writer, you will make money selling puts as well.

When one buys a put option, he pays a premium for having the potential to sell a stock at a given price in the future if it lands in-the-money. The seller of this contract receives a premium for taking on the risk that he may be indebted to buy the stock at expiration.

Sell Put Options Example

Now contrary to the example from the previous strategy, you do not own MCD but would like to get into the stock should it fall to a certain price.

But in the meantime, you are bullish on MCD at a current price of approximately 97. You see a support level just above the 94 level. Hence you might believe that it’s unlikely for price to decrease down to 94 believing in a positive outlook for MCD plus the technical analysis going in your favor.

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As a result, you can sell a put option at 94 and collect a premium of $5.00 ($500 for the entire contract). If you are right and the stock increases, stays the same, or decreases mildly (but stays above 94), then you will keep this premium of $500. If you are wrong and this stock expires below 94, you still keep the premium but lose $100 for every 1.00 decrease in the stock’s price.

So if this stock closes out at 90, this trade finished out-of-the-money by 4.00. This would be a loss of $400 (since 100 shares are included in each options contract). However, since you collected $500 in premium, you would still be net profitable on the trade by $100 ($500-$400).

Moreover, you were able to get into the stock at a price you wanted (94). However, if you begin to fall below your break-even point (89), you can always sell options before expiration to limit your losses or even lock in a partial gain (e.g., if it was still trading above 89).

If you close early, you aren’t obligated to buy the stock. Engaging in a strategy where you sell put options does come with risk, but it can be managed as the options writer by closing your position before expiration.

But overall, many investors sell put options to buy stocks that they would like to have, but feel is selling at a price too high for their tastes. Nonetheless, they can still make money with this particular options strategy while they wait.

Conclusion

The one thing that I must say about each of these strategies is that it’s important that you should ideally sell options on stock you own. The risk can become very large if you do not own the actual shares for which you’re writing the contract.

If you are writing naked options, where you don’t own the shares pertaining to the contract, the risk level involved with selling options is much higher because then you’re on the hook for the shares if your option expires out-of-the-money and the profit-loss will be worse the further out-of-the-money the option lands.

But if you already own the shares or want to own the shares, then the downside isn’t very high.

You’re either collecting premium, or collecting the premium in addition to buying or selling an asset that you were okay with doing by virtue of writing the options contract in the first place.

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