First, What are Options?
Learn how to maximize your portfolio and cash flow with the new investor’s guide to selling options right here! First, let’s understand what options are. A stock option is an agreement or contract which gives the owner rights to buy or sell a number of shares. These shares are bought at a specific price and within a specific and predetermined period of time. Options are derivatives. This implies that the value of options depends on the value of some other asset and they help to prevent downside losses and also generate recurring income.
As a new investor, selling options is one of the safest securities to invest your funds in, and this post will highlight everything you need to get started.
First, you should know that options are divided into two main parts: CALLS and PUTS.
A call option gives the owner the right to buy assets or a specific number of shares. These assets can be bought at a specific price and within a specified period of time. On the other hand, a put option is quite different. It gives the owner or holder rights to sell an asset within a specific period of time. These asset or shares can be sold at a specific price.
Thus, as expected, the options market has four major categories of investors: put buyers, put sellers, call buyers and call sellers. The options market gives you a wide variety of options. As such, it is an effective strategy for preventing losses.
Now that we Understand the different kinds of Options and what they mean, let’s discuss how they can be sold.
How to Sell Options
Unlike buying options, selling options actually gives you an obligation. When you sell options, you are obligated to sell an underlying equity or asset to the buyer. If the buyer decides to exercise his option, you are obligated to sell to him. A person who sells options is called the writer and as a new investor, you can either sell call options or put options. These entail different processes;
Selling Call Options
There are two ways of selling call options. You can either sell a covered call or an uncovered call. When you sell a covered call, you sell the rights to buy an asset that you own. For example, let’s assume you own a home or a building that has a value of $300,000. You may choose to offer a potential buyer the rights to buy the house at that fixed price within a period of two years. The buyer pays a down-payment which is known as the premium.
In this case, the premium may be $15,000. If the value of the house goes up to $500,000 within a year, it has no effect on the strike price. You will still be obligated to sell it at the strike price if the buyer decides to exercise his rights. If the buyer fails to buy the house within the agreed upon period, the option contract will expire and in this scenario, he will then have to buy it at the market price. Whether the option contract expires or not, the seller still gets to keep the $15,000 premium.
On the other hand, selling uncovered call involves selling assets which you do not own at the moment. It is considerably more risky than selling covered calls.
Selling Put Options
Put options are quite similar to insurance. When you sell a put option, you sell the right to buy shares at an agreed upon price. The buyer pays a premium for the right to sell the shares if the price goes lower. If the price decreases, the buyer then exercises his option rights. However, if the price rises above the strike price, the buyer will not exercise his option rights. In this scenario, the seller or writer gets to keep the premium.
What are the Advantages of Selling Options?
As a new investor, selling options can be a very profitable venture. Here are some benefits of selling or writing options:
- You get paid your profit immediately: When you sell options, the buyer makes an immediate down payment known as the premium. So, you get your profit immediately. If the buyer decides to exercise his options, you equally make profits from the sale.
- As time elapses, your risk is reduced: As time goes on, the value of an asset or shares reduces. Thus, you can always buy back your options at a cheaper rate. In the same vein, you also gain massive returns if the value reduces. Because the strike price has been fixed, the buyer will have to pay the fixed amount. Even if the value of the asset decreases, the buyer will pay the strike price if he wants to exercise his options.
- You get profits if the fixed time elapses: Once the specified period of time elapses, the options contract expires. Thus, you get to keep the entire premium which was paid by the buyer. If the buyer still wishes to buy the asset, he will need to buy it at the current market price.
A lot of new investors make very common mistakes when trying to sell options. Here are some that you should definitely know to avoid.
Top Mistakes to Avoid When Selling Options
Selling options is a very profitable venture. However, it can be quite risky. Little mistakes could lead to a substantial loss. As such, it is best to avoid any costly mistake or miscalculation. As an investor seeking to sell options, here are some top mistakes to avoid:
- Failing to develop a plan: Selling options involves a lot of critical thinking. To stay afloat this competitive market, you need to plan ahead. If you do not make adequate exit plans, you may suffer substantial losses. So, every investor involved in options trading needs to develop a well thought out plan.
- Fixing unfavorable expiration dates: Expiration dates can either rake in profits or incur losses for you. When fixing an expiration date for an asset, it is important to study the stock market carefully. Failure to do so could cause you to set an unfavorable expiration date, thus incurring losses.
The options trading market is an interesting and profitable one. If you are a first-time investor, you may want to consider selling and buying options. However, it may be risky and mistakes and miscalculations could lead to substantial losses; So, you would need to strategize and consider probabilities in order to make a profit.
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