There are many options trading strategies out there, but which trading strategy is the best?
David Jaffee of BestStockStrategy.com encourages investors to sell option premium.
While less glamorous than buying options and trying to hit home runs using other options trading strategies, traders can maximize profits and minimize their risk by selling options.
But, why should you focus on selling options?
Keep reading to learn about call and put options, including the benefits of selling versus buying option contracts.
What is call and put?
A call and put are options contracts that enable the buyer (and seller) to buy (sell) 100 shares of the underlying stock at a set price prior to a specific date.
Put and Call Options Explained
Options are contracts. If you own an option, you have the right to sell a specific asset at a price that has been predetermined.
You have until the option’s expiration date to sell, but you are not obligated to do so.
Traders use options to expand their portfolio, earn additional income, and hedge against potential losses.
David Jaffee’s online options trading course teaches his students how to earn a consistent income selling option premium, complementing or replacing their current source of income.
There are risks involved with trading options.
As derivatives, the value of your option depends on the price of another asset.
If you are new to the world of options trading, you will come across two terms very often: put options and call options.
With a call option, the owner can buy a stock at a certain price before the expiration date.
On the opposite side, a put option allows the owner to sell a stock at a specified price before the expiration date.
David Jaffee has found the most success selling option premium for both call and put options.
By selling option premium, you collect the premium paid by the buyer for an option.
This options trading strategy tends to carry less risk and a higher probability of earning a profit because the actual volatility is oftentimes less than the expected volatility.
Call and Put Options Examples
If you sell a call, you collect the premium on the option.
The option’s buyer now has the right to buy the underlying asset at the predetermined strike price before expiration.
Investors buy call options because they think the underlying asset’s price will increase before the expiration date (and that the magnitude of the increase will exceed the strike price plus the premium paid).
If an investor thinks the price of the underlying asset will decrease before the expiration date, they can sell the call.
Consider a call option example involving stock XYZ with a premium of $1.50 per share.
David Jaffee would encourage traders to earn $150 for selling the call option and collecting the premium for one contract (which is the equivalent of 100 shares of stock).
The buyer of the call option pays $150 in premium. If the option has a strike price of $35 and shares of XYZ are selling for $45 upon expiration, the buyer can exercise their right to purchase 100 shares at $35.
They are then able to sell the shares at the current market value for $45 per share. The call option buyer’s profit is the total amount earned in the sale of their shares minus the total investment, or premium paid.
In the example above, the option buyer would profit $850 due to the $10 increase in stock price less $150 paid for the 1 contract (which is equivalent to 100 shares of stock).
While the potential profit for buying a call is unlimited, it is a low probability trade.
Insurance companies are profitable because the premium they collect exceeds the premium they pay.
In the options / derivatives market, it's similar, where options buyers tend to lose money, in aggregate, because the premium they pay is less than what they receive once the contract expires.
The profit for selling options is limited to the premium collected, but selling options provides a higher probability of profit (albeit with less upside).
Selling put options, or writing put options, is similar. The seller collects the premium for the put option.
Consider a put option example involving stock XYZ with a premium of $0.75 per share.
The put option writer collects $75 in option premium.
The buyer of the put option pays the $75 premium for the right to sell 100 shares of XYZ at a strike price of $200 by the expiration date.
If the stock stays above the strike price, the put option seller will keep the $75 per contract and the option will expire worthless.
If the underlying stock trades below $200, then the option writer can roll / manage the position or they buy 100 shares of the stock at $200.
Again, the maximum profit for selling a put option is the premium collected.
The risk associated with buying put options is that the put buyer loses the premium paid.
When selling a put, the maximum loss would occur if the stock goes bankrupt (requiring the option seller to buy the stock at the strike price).
Puts and Calls for Beginners
If you find yourself looking for the “call and put options for dummies” explanation, you are not alone.
While selling option premium is a reliable way to earn a profit, knowledge and patience are required for success.
David Jaffee’s online options trading course is great for all skill levels.
You can learn options trading for beginners by diving into foundational topics, including the best options trading strategy.
Once you learn the ropes and get comfortable selling options, you can learn how to take calculated risks and increase your profits.
Start learning about puts and calls for beginners today with David Jaffee.