Trading Options

As an informed trader, it is important to learn how to buy and sell options. You can use options to protect or hedge your stock portfolio, to speculate, and to generate income.

Basically, while holding a long position in an underlying stock, an investor will sell (or write) covered calls on those shares in order to receive income.

Let’s say you own 100 shares of XYZ. You then sell 1 call option (1 call is equivalent to 100 shares of stock) to an option buyer. The buyer pays a premium ( cash) for the rights to those 100 shares at an agreed-upon price (strike price). You get the cash up front while the option buyer receives the right to buy that stock.

Example: You own XYZ Corporation, which is currently $33 per share. You sell 1 covered call at a strike price of $35 per share. Why sell an option? For the money. The cash premium ( the amount depends on the call option price, which constantly changes) is yours to keep. If the stock price rises within a certain time period, ( which could be anywhere days to years), you might be required to sell the shares. That happens when the stock is over $35 when expiration arrives. On the other hand, if the stock drops in price, the option will expire worthless but you sell keep the premium. Also, because you still own the stock, you may have unrealized losses on the stock. Nevertheless, the premium you received will help offset the losses.

This strategy, which is flexible and costs little, has been used for years to generate extra income or cash flow. In a way, you’re renting your stocks to other people and they pay you for the privilege. The strategy has a dual purpose : to enhance earnings and offer some protection against loses.

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