Some of the most profitable and productive trading is accomplished through selling options for income. You can make money on the way up and on the way down, in any market. By selling options, you control all aspects of your capital, including risk outcomes on particular trades. However, it's critical to understand the amount of money you want to spend and as well as timing the best execution or liquidation of the contract.
When it comes to options, things are much different than stocks, ETFs, and dividends. When selling options, you have a contract that you can sell to other traders for more than you originally spent on it. Whether you are new to this trading class or a seasoned veteran, it is essential to understand the pros and cons listed below before.
Pros of selling options for income
There are definitely benefits when it comes to selling options. As a trader, you have the potential to stack a lot of money. Here are a few highlights we want to cover.
You can create a steady and consistent revenue stream using options selling.
In the past few years, there has been a noted explosion of retail traders in the market. Unfortunately, these traders don't often struggle at first and these options buyers and are trying to find value more immediately, often trading with emotions. Trading requires risk, including possible losses, but understanding, researching, and studying require time and years of experience can combat some of the risk.
Option sellers can take advantage of this phenomenon in the pricing model used by stock exchanges. Option prices are set by the exchange using "bid" and a "call" prices which essentially tell traders how much the option may be worth at any given time.
As a result, option sellers have little reason to overreact to news or rumors about specific assets. Instead, with an understanding of the market and technical analysis, selling options for income creates consistent returns while also protecting your larger trades.
You can capitalize on the idea that volatility and complexity are typically overstated.
It is essential to understand: unlike futures contracts, options do not provide any information about the future performance of an asset. Therefore, there is no true way for traders to know how much an option may be worth at any given time in the future.
Trading options is more than simply buying and selling a stock or commodity. It involves a lot of psychology – both about the market, other traders in the market, and yourself. Unfortunately, there's a lot of information floating around about the best platform for research, exchanges, and more. So, you wind up doing more reading about how to become a successful trader than actually becoming a successful trader.
However, analyzing options and knowing how to price them accordingly can be some of the most critical skills for option sellers. Understanding the potential downside of an option can help determine its fair value. And, knowing when to sell a position for the best possible gain can get you (and keep you) in the green. One of the best ways to understand the risk and reward of an option is to look at how the price has changed over time.
While SPY options can be extremely risky, understanding how SPY options are priced can help option sellers determine if the market overall is gaining or losing value with every day that passes.
You can cover trades and use options to always stay ahead.
If you get into trading because you enjoy learning about markets and saving money, you probably don't need much convincing. But, some people are attracted to the idea of trading purely for enjoyment and the chasing of fortune (almost like professional gambling).
So, while it's certainly possible to earn a livable wage using trades, those so focused on making money fast also need some education on the defensive side of trading.
You learn how to read and interpret evasive, confusing signals, and you have to learn how to position yourself effectively in markets. Selling call and put options at the right time and in combination with market signs can transform your portfolio.
Unfortunately, selling options also a strategy that most options traders ignore. A better understanding of how markets work, how your personal biases affect trading decisions, and how to limit those negative influences on your trading can take you a long way in becoming a successful trader. Trading options can truly allow you to take control of your financial future.
Cons of selling options for income
There are, of course, also drawbacks when it comes to selling options. To earn money selling options, you must dedicate a substantial amount of time and money, which can be difficult if you do not have much trading experience.
It takes more time to research and utilize options selling.
There is a big difference between scalping and selling options. Scalping is taking a risk, understanding the size of the position and the potential reward or loss. Of course, this is a generalization, but overall this is short-term trading strategies.
The truth is that most people trading on a trend and following strategies related to selling options for-profit experience losses. That does not mean they are useless. However, it only means that they are less effective at generating long-term and significant single-trade profits.
It is nearly impossible to truly predict the future of the stock market.
Many systems try to predict upcoming movement based on past stock price trends. A significant advantage of this approach is that it's simple and can be implemented by anyone. This allows strategies to be deployed in many different market environments, including equity markets, commodity markets, real estate markets, and so on. However, even with the keenest log or understanding of the market, it is impossible to predict the future.
Why? The market is also affected by world news, outside factors, and environmental catastrophes. For example, look at COVID-19; the market experienced extreme lows and all-time highs over a year and a half.
If your options strategy is not set up to understand and compensate for these situations, you stand to lose quite a bit of money or getting involved in very challenging trades. With options selling, you have capped your upside potential in a trade but still left yourself significantly exposed with downside risk.
Just selling options will not take you "to the moon."
If you are selling options with a high strike, a good strike is worth 5% of the premium you paid for them. So, if you sold a call at $7 and got paid $10, you would be able to pocket 10% of the premium for selling the call for $7. Often, it isn't this simple.
You might have trouble imagining what your strike price would be without considering surrounding factors such as demand, the spread, and fees. You can increase your odds by discovering which options are highly rated by other traders. Knowing what others were willing to pay increases the odds that you will be sold the correct option at an attractive price. That said, not all options are created equal; pay attention to the expiry date, spread, and fees. Selling the best option gives a solid reward, and placing the wrong order can be destructive.
Singles Score Runs
The process of selling options does not elicit the same level of excitement as options buying, nor will it always be a "home run" strategy. Think about it like this: options selling is more akin to hitting single after single. Just remember, enough singles will still get you around the bases, and the score counts the same. Take time to understand the process of selling options. Options selling can bring additional stability and consistency to your options portfolio.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.