Selling Stock Options – Shooting For Consistent Returns

While stock options are usually thought of as an investment vehicle appropriate for taking risky, leveraged positions on underlying stocks, there are also conservative options trading strategies that many sophisticated investors use to improve their portfolio performance. There is a lot more to stock options than simply going long, or buying them, in the hopes of making a quick killing.

For every option contract that is bought, there is a party on the other side of the transaction who has sold the contract. Perhaps you’ve wondered exactly from whom you are purchasing an option; it’s frequently an individual who has completely different motives for entering the transaction first place than you do if you are the buyer.

The call option seller will normally have 100 shares of stock already in his account for every option contract that he sells on a given underlying stock (Apple, IBM, etc.). He can choose to offer the right, i.e. the option, to purchase the shares by a given date in the future, at a certain price–the “strike price”–that will normally be higher than where the stock is currently trading. In return, the option buyer pays the seller a “premium”, an amount of money that the option seller gets to keep no matter what happens.

The idea here is that if the stock rises by the expiration date so that it is trading above the strike price, the option buyer has the right to purchase the shares at the strike price then either hold them or sell them for an immediate profit. While the option seller is obligated to sell his shares at a price that is lower than the current market value, he still will have benefited from the run-up in share price from the time the trade was initiated until the stock reached the strike price.

If by the expiration date the stock price is below the strike price, the option will expire “out of the money”, worthless, as the right to purchase something at a price that is higher than the current market price is worthless if there is no time remaining on the right. In this case the option buyer will lose 100% of the amount that he invested in the position. The option seller on the other hand not only gets to keep the premium paid by the buyer, he also keeps his shares. Keeping the premium means that in effect his cost basis for buying shares in the first place is lowered, and he is better off for this reason than if he hadn’t sold the option.

There are many ways that one can invest in stock options, using both buying and selling strategies, often at the same time. In addition to these conventional “vanilla” options there are more esoteric types of contracts such as binary options, about what you might be interested in learning. There is no shortage of information on the Internet to get stock options explained to you in detail.

Leave a Reply

Your email address will not be published. Required fields are marked *