Options are sometimes seen as too complex and risky. That may be true if you’re using options to speculate. But, they’re often less risky and have a higher potential for returns if done the right way.
An option income strategy involves selling options (contracts) for premiums (the cost of the contract) in an effort increase cash flow. Each option represents 100 shares of underlying stock. Buyers of these options get the opportunity to benefit from future price changes during the time of the contract.
There are two types of option income strategies: call options and put options. Sellers get income from the premiums on each, but are obligated to sell (calls) or buy (puts) shares at the agreed price on or before expiration. Everything covered here is for US style options.
Call options overview
Call options sellers (writers) offer the right for buyers to purchase stock at a set price (strike price) until the expiration date. The writer is obligated to sell at that price — even if it’s lower than the current market price. Call option writers benefit from the income received from the premium, but risk lessening their profit if the option is exercised.
Put options overview
Put option writers offer the right for a buyer to sell stock at the strike price, to the writer, any time until the expiration date. If the option is exercised, the writer is obligated to buy at that price — even if it’s lower than the current market price. Put option writers benefit from the premium income, but risk having to buy the underlying stock at a loss if the option is exercised when market price is below the strike price.
How does an Option Income Strategy Work?
Factors such as volatility and type of option affect option pricing. But, time decay has one of the biggest effects. As an option gets closer to its expiration, its value decreases. This is due to there being less time for a beneficial balance between the strike price and market price for a buyer.
Market prices will affect strike prices and determine how they get classified. Strikes are classified as either: In the Money, At the Money, or Out of the Money. For call options, if it’s In the Money, then the market price is higher than the strike price. If it’s Out of the Money, then the stock price is lower than the strike price. For put options, the opposite is true.
Premium prices are listed as per share. To determine the total cost, you would need to multiply it by 100 (total shares in option). For example: a $2.50 listed premium multiplied by 100 equals a $250 total premium.
How call options work
Call options are much like a contract between a property owner and interested buyer. The property owner might require a non-refundable deposit reservation fee for the right to purchase it during a set amount of time at the price in the contract. If something happens before the expiration date that lowers the property’s value, the buyer won’t go forward with the purchase. But, the property owner still gets to keep the deposit.
EXAMPLE (Seller’s Perspective: Sellers collect the premium to boost income from their stocks)
XYZ stock trades at $48 and the call option has a strike price of $50 with a $2 premium and an April deadline.
- Your premium for selling the option would equal $200 ($2 x 100 shares)
- The buyer would choose not to exercise the option if the market price at expiration ends below the strike price, the seller (you) keep the $200
- But, if the buyer exercises the option because the current price exceeds the strike price, on or before the April deadline, you sell your 100 shares at the $50 and still keep the $200 premium
How put options work
Put options are like the contract between an insurance company and insured. Insurance companies charge people a premium to cover the cost of repairing future damage of an asset. They are obligated to pay the insured if covered damage happens to the asset. But, if no damage happens to the asset during the policy contract, the insurance company never has to pay out to the insured.
EXAMPLE (Seller’s Perspective: Put sellers receive a premium to buy shares at the strike price prior to expiration.)
XYZ stock trades at $42 and the put option has a strike price of $40 with a $2 premium and a June deadline.
- The income earned by selling the option would equal $200 ($2 x 100 shares)
- The put buyer would choose not to exercise the option if the market price of the shares ends above the strike price of the put. The seller keeps the original $200 premium
- But, if the buyer exercises the option because the value of the shares is below the strike price at expiration, you (the seller) purchase 100 shares at the strike price and keep the $200 premium received when the option was sold
As you can see, selling calls and puts are great option income strategies that can benefit your portfolio.
Let Snider Advisors Help
The goal Snider Advisors has for our clients is to help them generate a monthly cash flow as close to 1% of their total investment as possible. Additionally, we want to help them avoid any permanent loss of capital.
This is accomplished through option income strategies using the Snider Investment Method. This is a set of rules and steps — built around logic, reason, and probabilities — repeated monthly. Since it’s not based on emotion or hypotheses, it works well for both novice and experienced investors.
For those who want to do the work themselves, we offer video training, guidelines, and worksheets. In addition, we can give you ongoing support as long as you need it.
For those who prefer full-service portfolio management instead, we can do all the work of the Snider Investment Method for you. Then, you get to just enjoy the results.
Contact us for a FREE CONSULTATION to determine if the Snider Investment Method is the right fit for your portfolio.
