Options trading sounds risky, and it can be, but there are plenty of option trading strategies that have a low-risk tolerance. One of the most popular options trading strategies that is in the Safer Category for Call Options is Selling Covered Calls. The investor’s long position in the asset is called the “cover” because the seller can deliver the shares if the buyer of the call option chooses to exercise the option.
Trading Options is Double Duty Passive Income
Selling options can be an excellent way for a wise investor to gain extra income from their already passive income stock portfolio. PASSIVE INCOME = HANDS-OFF. Once you set up your options trades, and have set your limits and stop losses, you are mostly hands off, right?
The Call Option Defined
An option is a contract to buy or sell a specific security, usually a stock or ETF, at a specific price for a period of time. There are two kinds of options: calls and puts. Call options grant an option holder the right to buy the underlying security at a specific price (called “the strike price”) at any time prior to the end of the contract (“the expiration date”). You can buy or sell call options.
There are two flavors for trading call options: Buying and Selling. See below for which one works best for you, and fits the current economic landscape.
Buying Call Options
Investors often buy calls when they are bullish on a stock or other security
When you buy a call option, you pay the premium for the right to buy the underlying stock at the strike price on or before the expiration date. If you buy options, you start out with a net debit in your account. You will need to recover the money spent if you don’t sell your option at a profit or exercise it.
Your net profit = Income – cost of premium
Selling Call Options
When you sell a call option, you receive the premium but you are obligated to sell the underlying stock at the strike price, if assigned. You begin with a net credit because you collect the premium first. If the option is never exercised, you keep the money. If the option is exercised, you still get to keep the premium, but are obligated to sell the underlying stock if assigned.
If assigned, your net profit = premium + difference between strike price and stock purchase price (if any)
If not assigned, your net profit = gain in value of stock (if any) + premium
What Is an Option Worth?
The relationship between the strike price of an option to the price of the underlying security is an important one. An option has intrinsic (or built-in) value determined by how much it is In the Money. A call option can either be In the Money (ITM), Out of the Money (OTM), or At the Money (ATM).
|In the Money (ITM)||the strike price is LOWER than the market price of the underlying security|
|Out of the Money (OTM)||the strike price is HIGHER than the market price of the underlying security|
|At the Money (ATM)||the strike price is the SAME as the market price of the underlying security|
NOTE: the deeper out-of-the-money you go when selling covered calls, the less likely the stock will hit the strike price and force you to sell your shares. However, the deeper out-of-the-money the contracts are, the cheaper they are, for good reason, and the income you will be able to generate will be considerable lower.
Weekly Options: Bring on the Triple Lattes
If you trade options in your sleep — or can’t sleep — and a whole month (or even a few weeks) can seem like an eternity for your contracts to expire, you will be pleased to know that the CBOE (Chicago Board Options Exchange) has made it so that you can trade high-volume, popular stocks and ETFS on a weekly expiration schedule: you begin trading on a Thursday and the contract expires the following Friday.
Note that no new “Weeklys” are listed that would expire during the expiration week for standard options (the third Friday of each month), so the new expiration calendar doesn’t get confused with the current one. (If they didn’t do that, would we have “Quadruple Witching Day”??)
Here is a list of some of the top “winning” stocks/ETFs (the ones that are on the “Weekly” CBOE list):
Equities: AAPL – Apple Corporation ABX – Barrick Gold Corporation AMZN – Amazon.com Inc BAC – Bank of America Corporation BIDU – Baidu, Inc. BP – BPC – Citigroup F – Ford Motor Company GOOG – Google Inc. GS – Goldman Sachs Group, Inc. POT – Potash Corporation of Saskatchewan XOM – Exxon Mobile
ETFs: EEM – iShares MSCI Emerging Markets Index FAS – Direxion Daily Financial Bull 3X Shares FAZ – Direxion Daily Financial Bear 3X Shares GLD – iShares SPDR Gold Trust IWM – iShares Russell 2000 Index QQQQ – PowerShares QQQ TrustSPY – SPDR S&P 500XLF – Financial Select Sector SPDR
Weekly Payday, or…?
If you’re good, this could be like a weekly paycheck. If you’re wrong, you could go down fast – really fast, like say, three times faster, so this is probably a good time to bring in the usual warning about trading options:
Options carry a high level of risk and are not suitable for all investors. Certain requirements must be met to trade options. Options strategies using multiple-legs (two or more orders executed at same time) will involve multiple commissions.
With long options, investors may lose 100% of the principal invested. Spread trading may only be done in margin accounts. Please get and read a copy of the Options Disclosure Document entitled “Characteristics and Risks of Standardized Options” from the CBOE before considering any options transaction.
Stay tuned: the CBOE continually adds Weeklys available for trading. Be safe, trade well.
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Disclaimer: All the information provided above and on this site is for informational purposes only and should not be considered as professional investment, legal, or tax advice. You should conduct your own research or consult with a professional financial advisor when investing.