Selling options can be a lucrative strategy for generating income, but it’s important to understand the basics before jumping in. The trading strategy has been increasing popular in the financial independent or FIRE community. Don’t get me wrong. Options selling is not risk free. However, it is considered safer than buying options. In this guide, we’ll cover the fundamentals of options selling, including what it is, how it works, and the risks and rewards involved.
Selling Options is like Selling Insurance
Option selling, also known as writing options, involves selling options contracts to other traders or investors. Some examples of options selling strategies include cash secured puts, covered calls, bull credit spread, bear credit spread, and many more. When you sell an option, you are giving the buyer the right, but not the obligation, to buy or sell an underlying asset (aka a stock) at a specified price (known as the strike price) within a specified period of time (known as the expiration date).
Types of Options
There are two types of options: calls and puts.
- A call option gives the buyer the right to buy the underlying asset at the strike price
- A put option gives the buyer the right to sell the underlying asset at the strike price
How Does Option Selling Work
When you sell a call option, you receive a premium from the buyer and agree to sell the underlying asset to them at the strike price if they choose to exercise their option. When you sell a put option, you receive a premium and agree to buy the underlying asset from the buyer at the strike price if they choose to exercise their option.
The Risks and Rewards of Options Selling
The main risk of options selling is that if the price of the underlying asset moves in the opposite direction of your trade, you may be forced to buy or sell the asset at a loss. Additionally, if the buyer chooses to exercise their option, you must fulfill the obligation to buy or sell the asset.
However, the rewards of options selling can be significant. Selling options allows you to collect premiums upfront, which can generate income even if the trade does not result in a profit. Additionally, selling options can be less risky than buying options, as the seller has more control over the trade.
Final Thoughts
Options selling can be a complex strategy, but with a solid understanding of the basics, it can be a powerful tool for generating income. It’s important to carefully consider the risks and rewards before entering into any options trade, and to always have a solid plan in place. With patience, discipline, and a willingness to learn, options selling can be a valuable addition to any trader’s toolkit.
If you’re not a novice, jump straight into our option selling screener and start trading!