Trading Options for Income
If you are looking for new ways to generate income, consider using options. According to Investopedia, an option is "a contract sold by one party to another party which offers the investor (holder) the right, but not the obligation, to buy (call) or sell (put) at an agreed-upon price (strike) during a certain period of time." People trade options for three reasons: to speculate on a security's performance, to insure a position against market loss or to generate income. Investors can generate income by writing covered calls, naked puts or covered combinations.
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Covered Calls
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Investopedia defines a covered call as "an options strategy whereby an investor holds a long position in an asset and writes (sells) call options on that same asset in an attempt to generate increased income from the asset." Writing covered calls is the safest income strategy, as the most the writer can lose is stock they already own. Set the strike price where you're comfortable selling the stock, and be prepared to make delivery at a price below the current market value.
Naked Puts
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A naked put is defined by Investopedia as "a put option whose writer does not have a short position in the stock on which he or she has written the put." Naked put writing is the riskiest income strategy, as the put writer may be required to buy stock at a price higher than the current market value. Set the strike price where you're comfortable owning the stock, and be prepared to take delivery.
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Covered Combinations
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According to Investopedia, a covered combination "involves the simultaneous sale of an out-of-the-money call and a put with the same expiration date on a security owned by the investor. In other words, it is a combination of a covered call and a short (naked) put position." Investors use this type of strategy when they're bullish on a particular stock. They want to generate income and are willing to either sell their shares if the price rises or own additional shares if the price drops. Set the strike prices where you're comfortable selling out of your current position and taking delivery of additional shares. Be prepared for investors to exercise on both sides of the trade.
Considerations
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Options are risky, especially when writing against uncovered positions. Remember that the stock's market price isn't required to cross the strike threshold before investors can exercise. Tax strategies motivate investors to call stocks that are out of the money, or haven't reached the strike price yet, and sell them at a loss. When writing calls or puts, be prepared to make or take delivery at the strike price no matter what the market price is. If you're inexperienced in trading options or unfamiliar with option strategies, consult a financial professional first.
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