I’ve been writing about options strategies a lot lately – particularly selling options, because it’s an excellent strategy for generating income in markets like this one.
With so many people interested in learning more, let me go into more detail on how selling options works and tell you how I first came across options. It was not in the usual way.
Like learning about the birds and the bees, I found out about options in the streets. Literally.
I was sitting on a stoop in Lower Manhattan when a friend introduced me to the concept. “You can buy 100 shares of stock for pennies on the dollar, and if it goes up, you make huge money,” he explained.
I was wary. After all, this friend had tried to get me involved in a Ponzi scheme just a few months earlier. I didn’t even know what a Ponzi scheme was at the time, but it didn’t pass the smell test.
This felt different. So I went to the New York Public Library to investigate, and what do you know? My friend wasn’t working an angle. It was all true.
I was smart enough not to dive right in and start trading options. I was still learning about stocks, so I didn’t know what I didn’t know about options. But that changed over the years.
I read everything I could get my hands on, talked to friends who traded options on the floors of various exchanges, and began experimenting on my own.
I had a few big winners, but like most people, I paid my “tuition” to learn some valuable lessons.
And then the breakthrough happened: I realized you could make money selling options.
You can sell an option, collect the premium, and then either buy it back later to close the position or – even better – if the option expires worthless, you keep all the money.
Now, don’t get me wrong, I still like to buy options and swing for the fences if I believe a stock is going to make a big move. But I am the income guy, after all. So my preference is the more conservative and consistent approach to generating income from options, which is to sell them.
Here are two simple options selling strategies that can put money in your pocket instantly. (For more on these two strategies, click here.)
When you sell a covered call, you buy a stock and sell a call option on that stock.
Let’s say you buy Coca-Cola (NYSE: KO) stock at $72. You could then sell a call option that expires on August 15, 2025, with a $75 strike price for $1.55 per share. You’d instantly pocket $155 per call, because options contracts represent 100 shares of the stock.
Once you sell the call, the buyer of the call has the right to buy 100 shares of Coca-Cola from you at $75 apiece at any time up until August 15.
If Coca-Cola is above $75, they may do so, but call buyers usually wait until the expiration date to make that decision. If the stock is below $75, the buyer will not exercise their option, so you’ll keep your stock and the premium you’ve collected. It’s like someone putting down a nonrefundable down payment on a stock while they decide whether they actually want to buy it.
Let’s look at the numbers to see the profit potential of covered calls.
If Coca-Cola is at or above $75 on August 15, you earn a $3 profit, because you bought the stock at $72. You also keep the $1.55 option premium and a $0.51 per share dividend.
So you’d make $5.06 per share, or a 7% return ($5.06 divided by $72 equals 0.07 or 7%), in three months.
Option contracts represent 100 shares, so by selling one call, you’d make $506. (Note that you have to own 100 shares of the stock to sell a covered call against it.)
If the stock is below $75, you still keep the $1.55 option premium and the $0.51 dividend for a total of $2.06 per share ($206 per call you sell), or a return of 2.9% in three months. But you also still own the stock, so you could sell another call after the first one expires and keep the money rolling in.
The risks are that the stock takes off and you miss the opportunity to sell it at an even higher price, or the share price falls and you lose money on the stock – though the $2.06 you made from the option premium and the dividend will reduce those losses.
You should only sell covered calls on stocks you are fine with owning but also okay with selling if they get called away.
Naked puts also sound like something I learned in the streets.
When you sell a naked put, you are giving the buyer the right to sell you a stock at a certain price by a certain date. You should only sell naked puts on stocks you want to own at a lower price.
Let’s say you’re interested in Coinbase (Nasdaq: COIN), but you think it’s too expensive at $253. However, you would like to own it if you can buy it for $220.
In that case, you might sell the July 18, 2025, $220 puts for $10. If the stock never falls to $220, nothing happens and you keep the $10 per share, or $1,000 per contract. You’d earn 4.5% ($10 divided by $220 equals 0.045 or 4.5%) on your money in two months, which is excellent.
If the stock does fall to $220 or lower, the owner of the put can sell you their stock at any time up until July 18.
The risk is that the stock falls below $220 and you’re forced to buy the stock at $220. But remember, you’d still keep your original $10 premium, so that would essentially lower your cost to $210.
In order to sell naked puts, you must have enough cash available to buy 100 shares per put you sell, just in case the stock falls and the buyer of the put exercises their option.
There are lots of other great conservative options strategies that can consistently put money into your account.
The best part is you don’t have to learn about them in the streets like I did.