For a decade after the 2008-9 stock market crash, savers earned little interest on their nest-eggs because interest rates were at rock bottom levels.
When bank savings accounts don’t pay much and bond yields are low, you can wait for the tide to turn towards a higher interest rate environment.
Or alternatively, you can proactively apply portfolio income strategies to make money routinely.
Trading options for income is a common method used by equity investors who are looking to create more cash flow.
Among the best options strategies for income are covered call writing and put selling.
Writing covered calls is perhaps the best options strategy for income while put selling is an options income strategy designed to buy stocks at a lower cost basis.
Below we explore how to trade options for income when writing puts and calls.
Table of Contents
How To Trade Options
For Income: The Basics
In order to use options strategies to make money, you first need to know options trading basics.
Unlike stocks, options have a fixed expiration date after which they can no longer be traded.
Each option has a fixed strike price too. It is the price level at which call writers agree to sell shares and put sellers agree to buy shares.
Traders who write call options and sell put options are paid an amount called a premium to agree to a contract.
The only reason that call writers agree to sell their shares at a strike price upon a certain date is because the earn income from premiums paid to them.
Similarly, put sellers agree to buy shares at a fixed price upon a certain date only because they are paid to do so.
You might be wondering who pays these traders using options for income?
The short answer is either another trader betting against them or a market marker whose job it is to provide a liquid market.
How To Earn Income
From Options: Covered Call Writing
When you sell a call option, you are effectively betting that a stock won’t rise above a certain price level.
On the other side of the trade is the call buyer, who believes the stock will rise higher than the strike price by the option’s expiration date.
They pay a premium for the option which gives them the right to buy the stock at the agreed upon strike price if they end up right.
And you receive that premium which obligates you to sell the stock to them if they turn out to be right.
As a covered call writer, the deal is a pretty good one because even if you end up wrong and the stock rallies much higher, you still get paid the premium.
And if the stock were to fall lower, you also keep the premium, generate income, and lower your overall cost basis.
Covered Call Writing Example
To keep things simple, let’s assume the stock you own is trading at a price of $90 and you don’t believe it will rise above $95 anytime soon.
You could write a covered call at strike 95 and get paid a premium.
We’ll assume you get paid $3 per share, or $300 per contact, for selling a single call option contract.
Now, if the stock is below $95 upon the expiration of the call option contract, you keep the $300 and still own your stock.
However, if you bet wrong and the stock rises to $100 per share by expiration, you are obligated to sell your stock at $95.
The silver lining is you still get to keep the $300.
In the short term, it looks like you are worse off for having sold the call option. After all, had you simply held onto your stock and not written the call, you would own stock that is now priced at $100 per share.
So why write calls at all?
If you are trading options for income, writing covered calls is among the very best options strategies.
On the months that you are not obligated to sell your stock, you generate income from the option premiums.
And on the months when you are required to sell your stock, you can always re-purchase shares after the expiration date on the next trading day and repeat the process.
Either way, you get to keep the options premiums month after month.
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Option Income Strategies:
You don’t need to already own a portfolio of stocks to generate options income.
Put selling is an options income strategy that pays you for agreeing to buy shares at prices below where they are currently trading.
Some traders think about selling puts as a way to get paid to buy a stock “on sale”, meaning at a lower price in the future.
Maybe you think the share price of a stock you would like to own is too high today but you would be happy to purchase it at a lower price in the future.
That’s when a put selling strategy can be useful.
You can sell puts that obligate you to buy stock if it dips below a specific price, the strike price, by a certain date.
By agreeing to buy stock if it is below the strike price upon the expiration date, you get paid a premium.
But what if the stock never falls and instead meanders sideways or rises?
That’s good news for you because you pocket the premium and can repeat the process next month.
Put Selling Example
Say a company on your stock watchlist is close to a price level where you would be happy to own it but ideally you would like to purchase it a bit lower, what can you do?
A “put selling for income” strategy would be ideal because you get paid to sell puts while waiting for the share price to dip lower.
Imagine the stock is trading at $68 per share and you would be happy to own it at $65 per share, you could sell 1 put contract for every 100 shares you are willing to own.
We’ll assume that you get paid $2 per share, or $200 per contract, for each put option you sell.
Fast forward in time and, if the stock is above $65 upon the expiration date, you keep the $2 per share option premium.
But what if the stock falls to $60 by expiration?
Then you have to fulfill on your obligation to buy the stock at $65 per share.
For each put contract you sold, you must pony up $6,500!
So, you can see that put selling can be expensive when you need to buy stock and is usually only appropriate if you can afford to buy the stock and want to own it.
Naked Put Selling
You already know that selling puts obligates you to buy stock when the share price of the company falls below an option’s strike price.
But did you know there is a way to lower your risk?
The put selling example above describes the process of naked put selling.
You can think of naked as meaning highly exposed to risk if the stock plummets.
In a worst case scenario when a company goes bankrupt and its share price crashes to zero, you would still be obligated to buy shares at the agreed upon strike price.
In the example above that means paying $65 per share for a stock worth zero!
If that seems scary, then other put selling strategies, like the put credit spread, may be more appropriate for you.
In the put credit spread, a put option is purchased at a strike price below the price at which you sold the original put in order to limit risk.
In reality, the chances of a blue chip company like Boeing going bankrupt are low but your capacity for risk may be a good barometer on whether naked put selling or put credit spreads are a better fit.
Using Stock Options To
Generate Income: The Bottom Line
If you are looking for portfolio income strategies to make money regularly, put selling and covered call writing are among the best.
All the best online options trading brokers cater to these option income strategies.
Covered call writing is ideal when you already own stocks and want to generate income from them.
Put selling is also lucrative but requires you to have cash reserves on hand in order to buy stock if and when it dips below a certain price level.
Naked put selling is a good strategy for income-oriented investors who want to purchase stock at lower price levels and get paid in the interim.
The bottom line is if you want to make extra income regularly, options are a valuable tool to help you reach your financial goals but assess the risks before dipping your toes into options trading.
What portfolio income strategies to make money do you use? Do you trade options for income? Share your best options strategies, we would love to hear from you.