On a very basic level, there are four types of options trades. Yet there are a ton of different options trading strategies out there. You don’t want to bite off more than you can chew right out of the gate. It’s very important to learn just as much about options as you know about investing in general.
The Covered Call
Let’s start with the covered call. This is considered a bearish strategy, but there’s much more to it than that. Whether you are bullish or bearish on a stock, you are providing yourself with some insurance. You can cover your position and limit your losses. Yet in some respects, you can also end up limiting your gains.
Writing a covered call means you are selling a call option. You own the underlying shares, and you agree to sell them at the strike price, if your position ends up in the money. You pocket the premium no matter what. It’s always best to make sure you are writing covered calls on stocks whose premiums are worth the move.
When you buy a call, you fork over a lot less money, and this money represents the premium you would be pocketing if you were the one selling the covered call. You are in essence controlling 100 shares of stock as well. People who buy calls often trade them within the allotted window of time.
Yet trading call options can be very risky, as they lose money over time if there isn’t a significant movement in the stock. If your call option expires out of the money, it becomes worthless. Buying calls, however, is a popular day trading strategy, and there is money to be made.
Selling puts is considered a bullish strategy, but it can be looked at with a different perspective, too. Some people sell puts to pocket premiums and allow themselves to purchase stocks they want at a cheaper price. Ideally, however, you’re looking for a stock to surge so that it never gets close to your strike price. You pocket the hefty premium, and you move on.
Selling puts can make you some nice money, but for the most part, you have to post the collateral. There are naked puts, but they are more risky of course. You would have to be cleared by your broker to sell puts as though you were buying calls, meaning you post less money to get the gains.
Buying puts isn’t the same thing as shorting a stock, but it’s the closest you get to doing so with basic options trading. You make money if a stock goes down. When you buy a put, you control 100 shares at a cheaper price.
You are buying the put because you believe the stock is going to go down in value over some time. You can profit off a put for a stock you believe in, however, so it’s not like you have to think the company is doomed.
Let’s say that a stock has been roaring lately along with the market, but you believe it’s time for a correction. You can make some money if you buy a put at a particular strike price, and that stock falls below your strike price.
Investors love to trade bought calls and puts. Covered calls are more for the income investor. Selling puts is more of a step up for the income investor, but you need to tackle one thing at a time here. You also need a sizable portfolio to get into the options game, meaning you have first learned investing and you have enough money to take on the covered call.
The covered call is where I suggest that you start. You have a portfolio, but do you have 100 shares of a particular company? Look at the call option premiums for those stocks you own. Write a covered call or two, and then I suggest you start looking into selling puts.
Leave buying calls and buying puts off the table for now. Look into those later if you want to take on that type of risk. First, you have to get to know yourself as an options trader. Then you can start making bigger moves.