Options are one area of stock trading that many investors are somewhat wary of- and quite rightly so. Buying and selling options requires quite a sophisticated level of financial understanding, over and above that needed for stock trading. And the risks that you are exposed to, particularly when writing (or selling) options naked can be high, in comparison to your initial outlay.
So why get involved in options trading at all? Well options form very useful risk-to-reward building blocks. By carefully choosing strike levels, expiry dates and the number of calls (right to buy) or puts (right to sell) in your option trading strategy,you can easily construct a tailored risk profile- one to suit your market outlook.
If you want to go risk heavy, because of a confidence in a stock market move, you can easily leverage your participation in that move, and so increase your profits, using options. You can make up a price insensitive risk profile, that makes money only if the market gets more volatile- you don’t take an opinion on which way things will move at all.
But equally, if you want to take careful advantage of smaller risk opportunities, in a relatively inexpensive fashion, there are options strategies that can meet that goal. Writing covered call options is one strategy that allows you to do so.
Here you already own the underlying stock. You then ‘write’ a call option on the stock options exchange, receiving a fixed premium for doing so. The strike should be higher than the current price. If the price rises above that level, your stock at market price, and the stock sell at strike, for the option, counteract one another. And you get to keep the premium.
Conversely, if the stock price falls, your option won’t be exercised against you, and the premium partially offsets modest price losses. So this is a great strategy to use when you want to hold onto the benefits of stock ownership, enjoy an immediate income, and have a limited protection against losses.