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Beginners Guide Beyond Stocks: Options Selling-Basic Strategies for Individual Investors

By Edited Feb 16, 2016 0 2

Have you considered learning some stock options trading strategies? Lately the stock market seems like a very scary and volatile place for individual investors. Wall Street professionals are paid to worry about the constant and frequent gyrations of the market, but for the rest of us, we just want to invest our hard-earned savings in ways that grow over our working lifetime, outpaces inflation, and provides a decent return on investment. In the past, I have spent money trying to time the market, and to “swing for the fences” with my investments only to now simplify. There are numerous options strategies for every level of sophistication, and for every market condition, but I have found that there are three (3) basic stock, equity, and ETF options selling strategies that every individual investor should know: the covered call, the cash-secured put, and the bull put spread.

If you choose to have individual stocks in your long-term taxable portfolio, or in a Roth or Simple/SEP IRA, then you should check with your online broker to ask for stock options trading authorization in your online brokerage account. Learn all you can about options before trading, and never initiate any trade that you do not fully understand. I have found that after using options for speculation, leverage, and more, that there are three simple ways to use options that are relatively conservative, but also extremely beneficial to me as an individual investor. These are options tools I can use on occasion that help me with my personal long-term wealth plan. 

The Covered Call

How Does It Work?: This strategy is the most common and widely known options strategy, and is often referred to as a Buy-Write. I own or buy stock in 100 share blocks and I sell the right to someone to buy it away from me at a later date at a fixed price. 

Give Me an Example: For example, I can buy 100 shares of Ford Motor Company (Ticker: F) for $1010 (100 x $10.10/sh) in November, and sell the right for someone to buy it from me in February for $1200. For that

Wells-Fargo-Stock-Options-Selling-Strategies
right, they pay me $26 dollars. If Ford is above $12/share in February, it leaves my account and I keep $1200 + 26 (transaction fees are not accounted for in these examples). If Ford does not move above $11.99 by February options expiration, I keep the $26 as a “layaway” fee for obligating my stock, and his/her option expires and my shares are no longer obligated to anyone.

Downside: If the stock drops a lot, the small premium isn’t much protection. If the stock rockets higher, I may regret obligating it at that strike price ($12 in the above example). For example November to February is only a few months and a move from $1010 to $1226 is more than 21% so if it happens, I think I’d be happy to sell at that price and take my gains, especially in a tax-deferred account. If I keep the stock and the $26 premium, my total cost is now lower ($1010-26= 984), so I have a better cost basis going forward. 

The Cash Secured Put

How Does It Work?: If I decide that I want a particular stock and I am willing to buy it right now on the open market, there is perhaps a better way! I can sell a Cash Secured Put (CSP) to obligate myself to buy. By selling a CSP, I am telling a holder of my favorite stock that if the price drops to $XX dollars, “don’t worry I’ll buy it from you.” To guarantee this with my broker, I have the cash in my account the whole time to do this. 

Give Me an Example: So for example, I decide that I want to perhaps buy 100 shares of Wells Fargo (WFC) today for 24.69 for a total of $2469 (minus fees). Rather than buy it outright in November, I decide to sell a cash-secured put for January for $24/per share. By selling this obligation, I am promising to buy 100 shares of WFC for $2400 with the cash waiting in my account, if it fall below $24. For this obligation, I will be paid a put “premium” of (for example) $148 dollars. After a couple months if the stock is anywhere below $24 a share, the stock will be mine, and the money withdrawn. If I was planning to buy this stock anyways, and I’m willing to wait a a few weeks, a month, or more, I will buy it for less this way. The danger of course is that stock drops to $15 or whatever and I still have to buy it for $24, I’m obligated... but only until January. If it drops a little, I am covered by the premium received. WFC put to me at $2400 - 148, my real cost is now $2252 (without fees), or $22.52/share. I think it’s a great way to buy stock because you’re being paid to buy it. If it stays above your strike ($24), you keep the $148, and you can sell another one.

Downside: Firstly, this requires enough capital to buy 100 share blocks of stock. For some that might be impossible. Also the real danger is really not having protection -- so if you promise to buy Bear Stearns for $30 a share, you have to do that even if it’s a $2 stock! Also remember, put premiums vary widely so you should never sell one for a stock you don’t want to own, and at a price you don’t think is good. Think -- if that was “ON SALE” -- I would buy it -- that’s my underlying philosophy with selling puts. The other downside is that you may not get the stock. If it never drops, your money is tied up so you’ll keep the premium, but you may not ever own what you wanted. (But in the example above-- if you obligated your $2400 for a few months and made $148 while you waited, but never got “put the stock”, you still made over 6% without buying anything.)

The Bull Put Spread 

How Does It Work?: This strategy is a bit more advanced because unlike a Cash Secured Put, you will have some protection with a Bull Put Spread. You are selling a Put to obligate a purchase but you are buying another below yours to obligate someone else. You can keep the difference when the calendar runs out, or take the stock, and sell your “protection” for a small cash gain.

Give Me an Example: If I sell a Bull Put Spread in Nvidia (ticker: NVDA) when it’s at 13.93 in November, I might choose options in March. I could sell a $12 put for $103, and obligate myself to buy the stock for $1200. At the same time, I buy a $10 put to protect myself for $52 dollars. This obligates another trader to buy NVDA from me at $1000 until that date, regardless of price. Here’s how the spread works... I can keep the difference between what I took in (sold) and what I spent (bought) if the stock stays above $12. So I sold at $103 and I bought at $52, so I can keep $51 (minus fees) if the stock stays flat, goes up or drops, but not below $12. If it drops from its example price of $13.93 to $12, and I have the money in my account (CSP), I can (re)sell the $10 put before March for a small gain to help offset the costs of my new stock purchase at $1200. If you sell this on stocks you are optimistic about (bullish), you may often just keep the premium.

Downside: Although in this example, you can make money if the stock goes up, stays flat, or goes down very little, the risk here is obviously you aren’t protected until $200 below your put. You sold $12 strike, but your “insurance” doesn’t kick in until $10 so you could lose $149 quickly ($200 difference in strikes - $51 you collected). Again this works best with stocks you want to own, with the possibility of converting to a cash-secured put (CSP) at the last minute.  

Summary

After spending a few years buying options, only to watch them quickly decay in value and time, I started to embrace these three strategies of basic selling options: covered call, cash-secured put, and bull put spread. Each of these allows you, the individual investor, to collect some money while you wait to do a trade in a stock, equity, and even an ETF (tradeable basket of stocks or index). Remember that the options markets are fluid, and the prices change constantly to represent the movement of the underlying stock price, the overall market volatility, and other factors like time decay, strike price, and calendar ramifications. Make sure you learn as much as you can before you make an options trade - there are a lot of options education resources available. And be sure to consult your own tax advisors, accountants, financial advisors, and others before you commit any risk capital. In full disclosure, I currently own WFC and F stock.

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Comments

Nov 21, 2011 5:57am
KrisSigeti
Great information! I enjoyed your article.
Nov 21, 2011 8:27am
CapstoneTrends
Thanks Kris!
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