When I talk to traders, I tend to ask them if they understand options.
About 75% of the time, I find, regardless of their experience with stocks, most traders do not trade options.
The psychology of that answer in most cases comes down to intimidation.
Options can be very intimidating, but when they are understood properly, they unlock an entire world of income generation.
Options act like cheat codes in video games.
Sure, you can play the newest game, but it is soooo much better with those codes.
There are many different strategies for options investors, and not every strategy is suitable for every trader.
Today, I am going to give you a step-by-step on how to accomplish two specific goals.
- Set up a covered call options trade
- Sell a small stock position at a great price.
Do you have an existing stock portfolio?
I expect if you are reading this, you have already mastered the art of buying and selling stocks and have some positions you’ve held for a long time. Unless you are strictly looking for dividends, you probably expected the stock price to rise so you could sell it for a profit.
Many investors who get started trading options fall into a simple trap, buying long calls.
Long calls are great for speculative plays, but end up being a major disappointment since time is working against the buyer.
The best way for most stock traders to get started trading options happens to be selling covered calls. The reason is that it is in line with what you are hoping will happen: price appreciation with an added bit of premium. It’s the cherry on top of a delicious sundae. And since selling ‘covered calls’ are fairly easy to be set up by most trading companies, you can get started right away.
Let’s review how to set up a covered call:
Identify the position you would like to use.
Find a stock position where you have at least 300-400 shares, the more the better. It would be best to find a stock that is already trading for more than you paid and also does not pay dividends. Large dividend payers add an additional element that I won’t be covering here. We are going to start off selling 1 covered call contract.
Determine the price you would sell your shares for
After you have found the position you would like to sell 100 shares of within the next 30 to 60 days, it’s time to go to the chart.
We are going to use an old chart that perfectly illustrates my point.
As you can see on the chart below:
- The current price of the stock is 21.60
- The stock has traded within a 10 point margin over the past 12 months.
- The highest price it reached over this time was just under $30.
You could always attempt to see 100 shares of this stock by entering what is called a GTC sell order for a limit price of about $29.00 and wait. If PSSI reaches that target again over the next 60 days, the shares will be sold. If it doesn’t reach that number the sell order will be canceled. You might meet your goal of selling some of your stock at a profit, it does not accomplish your goal of completing an options trade.
Consider Selling a Covered Call
Another way to potentially accomplish your goal of making an options trade and also generating a larger profit from your holding would be to sell one covered call.
Simply put, a covered call is a strategy investors can use to generate income from their existing stock holdings. You sell one contract worth 100 shares of stock. That is why for your first covered call, you should have at least 300 shares.
In exchange for selling the call option, you receive option premium.
That premium you just collected comes with an obligation because you are now the seller of an option contract.
If that call option is exercised by the buyer, you may be obligated to deliver your shares of the underlying stock. Since you own the stock, you are covered, hence the name covered call.
The reason for writing calls is you hope to keep the shares while generating extra income off of the premium. You will want to stock price to remain under the strike price you sold the call contract for and if that happens you keep the premium and the stock.
Smart option traders will also take money off of the table in the middle of a trade, meaning if the stock you hold gets hit hard, and sells off, the value of that call will drop. Many times, even in my own trading, I would rather close out the position without keeping the entire premium.
Stocks generally trade between their support and resistance, and if you are a patient investor, which I know you are, you will do very well with covered calls.
Good fortunes… Eric, The Option Specialist
— The Option Specialist