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When you think about investing, selling options for income might not be the first strategy that springs to mind.
Investors use options to hedge their positions and traders use them to make quick gains when a stock moves up or down. They buy call or put contracts and hope to sell them for a profit or exercise them later.
But there are also options income strategies. For example, some investors sell puts for income. And when used properly, they can be part of a conservative investment strategy. We'll show you how.
You see, unlike stocks where your only option is to buy what's available, options contracts must be written first. And investors just like you can write them. What that means is you get paid for taking on the responsibilities of a contract.
Done right, it could mean a steady stream of options income into your account as options buyers fork over their cash to you.
Of course, there's some risk too, but that's what we're here for.
We are going to walk you through everything you need to know to sell options, from the basics of options writing to how to manage your risk and set yourself up for success, or even explore modes of income investing for retirement.
What Is Options Writing? How to Start Selling Options for Income
Writing an option is simply the act of selling an option you do not already own. When you write an option, your broker creates that option contract for someone else to buy. As the seller, you collect the money right away in exchange for fulfilling the duties of the contract.
You can either buy back that option at a lower price later to make a quick profit, or, ideally, you let the option expire worthless so you keep all the money you got up front.
Here's how that works:
When you write a call options contract, the buyer pays you the market price of the contract, which is called the premium. In exchange, you're obligated to sell the buyer the stock at the contracted strike price. As long as the stock stays below the contract's strike price, then you don't have to do anything. If the stock rises above that price, then the buyer can execute the contract and you're obligated to sell them the shares.
Selling puts for income works similarly. When you write a put option contract, the buyer pays you the premium for the contract and you're required to buy the stock at the strike price if the buyer executes the contract. As long as the stock stays above the strike price, then you don't have to do anything but collect the premium.
As you can see, selling options for income gives you the cash right up front, but if the trade goes against you then you could have to buy hundreds of shares of a stock at market price and sell them at below market value, in the case of selling call options, or you could have to buy hundreds of shares of a stock at an above market price, in the case of selling put options.
But options sellers have a few advantages in this arrangement.
First, time is on your side. Options prices naturally decay over time, especially as their expiration dates draw near. That's bad news for options buyers. But if you sold it, then the natural price decline works in your favor.
Second, about 30-35% of options expire worthless. Maybe 10% actually get exercised and the remaining 55-60% are closed out before they expire.
So, writing options puts the odds of success in your favor.
And as we'll show you later, there are two strategies you can use to tilt these odds even further in your favor, making selling options for income a viable investment strategy.
How Do You Sell Options?
Whether you buy or sell options, your account must first be cleared for options trading. This is something you can easily to with your broker, including Robinhood or sites like WeBull. Check your broker's website or give them a call to set it up. It is quite a simple process and you generally just need to acknowledge you understand the risks.
Once you're approved, trading options for income can be just as easy as buying or selling a stock. There will be a link on your broker's website to "trade" or "buy/sell." On that page or the next page, you will see "stocks," "options," and maybe "mutual funds." Select "options" and the order entry screen should appear.
Choose your underlying stock, put or call, the strike price and expiration date, and then select "sell" instead of "buy." You may also see "sell to open," which is what you want to do.
As soon as someone buys the contract, you'll see the premium show up in your account.
What Are the Risks of Options Selling?
As with all investing and trading, there are risks that you need to know about before jumping in.
When you write options there are different ways of handling the risk. You can do it in a low risk manner, but some traders do it with a lot of risk.
The two main ways to write call options are called "naked" and "covered." As you might expect, naked options selling leaves you exposed to big risks.
A naked option is just a simple sale of a put or a call. You can make money if the underlying stock rises (for a put) or falls (for a call). The problem is if the opposite happens. And it can be big. Selling naked options exposes you to theoretically unlimited risk.
We never recommend these high-risk trades. Investing is not about taking huge risks for the chance of huge rewards. Slow and steady is a far better way to make money over time, with the added benefit of letting you sleep well at night.
A covered call option, on the other hand, means you already own the stock when you write the option. Owning the stock "covers" your risk, even if the stock price soars. Your risk here is that you have to sell your stock at the contract price, but that's much better than the unlimited risk of a selling a naked call.
For puts, the name is a little different. The conservative approach here is called "cash secured put" selling. It is used when you want to own the stock, but at a lower price than you can buy it today. Cash secured means you already have to cash needed to buy the stock outright and don't need to rely on margin.
Here's how to use these strategies effectively...
How to Sell Covered Calls for Income
Selling covered calls for income is a great way to invest while limiting your risk. You may lose some upside potential if the stock skyrockets, so you are trading potential capital gain for actual income.
But this is a great strategy if you'd sell shares of the stock when it reaches your target price. You can simply get paid to hold the stock until it reaches your sell price. It's a win-win.
You earn your income from selling the option and if the stock does not rally up to your accepted price then you keep the income and sell another option, doing this over and over until the stock hits your target price. If it does make it to that price, you sell your stock at a higher price then where it was when you started and still keep the income.
By already owning the stock, you will not be at risk of having to go out into the open market to buy it at a higher - sometimes a lot higher - price, just so you can then resell it to the options holder. Your cost is already locked in, so your risk is pre-defined.
How to Sell Puts on Stocks You Want to Buy
The way to manage your risk when selling put options for income is called selling a "cash secured put."
The trick here is to find stocks you'd like to own if only their price was cheaper, then sell puts using your ideal price as the strike price. You'll get paid to sell the contracts until the stock hits your target, then you'll get to buy it at your preferred price. It's a win-win.
Basically, you name your price, write the option, collect the money for the option and wait to see if the stock price drops. The beauty - and the risk - is that if the stock price does not drop you still keep the money for selling the put. You also may not get to own the stock at a desirable price.
Let's say you want to buy Stock ABC for $45 per share but it is now trading at $48. You sell a put option with a $45 strike price and collect the money from the option. If the stock drops below $45, the option is exercised, and you must buy ABC at $45. You have the stock you wanted at the price you wanted to pay, plus you keep the options money.
One risk is that if the stock falls well below $45, you still have to pay the $45 price. Or, if the stock starts to rally then you may have wished you'd paid $48 for the stock.
In either case, you still keep the money you received for writing the option. By repeating this trade each week or month you can consistently add income to your portfolio.
How the Options Wheel Strategy Works
There is another multi-step strategy called the "options wheel" that is still suitable for beginners who want to earn consistent income but also with low risk. It works best with stocks you think have good long-term upside potential.
The first step is to sell a cash secured put with a strike price just below the current price of the stock. If the stock does not fall to your strike price, you keep all the money you earned for selling the put and then you repeat the trade.
You keep doing this until the stock falls below your strike price and the option is exercised. You'll buy the stock using the money you set aside.
Now you own a stock you think has long-term potential. With any luck, you were able to sell puts more than one time to earn even more income. But even if you only earned one trade's worth, you still have more potential income to earn.
The next step is to turn around and write a covered call, repeating each time it expires worthless. Now you are earning an income while you wait for the market to take the stock off your hands - at a higher price.
You earn a profit on the stock and you still keep all the income you made along the way.
For more information on how to prepare for a comfortable retirement, read the rest of our income investing for retirement guide.