Options strategies to generate income
Buy-Write Strategy
An option contract covers shares of the underlying stock and includes a strike price and an expiration month. Options are derivatives as they derived their value from the underlying assets.
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There are two types of options: call option and put option. When an investor expects the stock of a company will move upward in the future, he may buy the call option that gives him the right but not an obligation to buy the shares of the underlying stock at the strike price at or before the expiration of the contract.
He pays a premium amount to the option writer seller for buying the right.
On the expiration date, if the current market price of the stock is greater than the strike price of the call option, the buyer of the call will exercise its option. The seller of the option must sell the share at the strike price because it is his obligation. The buyer of the call gets the benefit of buying the shares at a lower price while the seller of the option enjoys the premium amount.
If the option expires while the share price is above the strike price the option writer keeps the premium and can sell another put option to generate additional income. The maximum loss of the buyer of the contract is limited up to the premium amount while the profit on the shares is unlimited. Position of the Call holder at different spot prices:. When an investor expects the price of the shares of a company will move down, he may buy a put option that gives him the right but not an obligation to sell his shares at the predetermined price strike price.
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The buyer of the put option gets the right to sell the shares of an underlying stock at the strike price by paying a premium to the writer. If the spot price of the shares is lower than the strike price of the contract, the put buyer will exercise its right and sell the shares of an underlying stock at the higher price strike price. The seller of the put has obligated to purchase the shares if the buyer wants to exercise its right. The seller of the put gets the benefit of the premium amount. They are increasingly embracing the cash-secured put sale strategy to create returns that generally far exceed what is available in the bond market.
This is one of the simplest options strategies in existence. We have long advocated this strategy , and now it seems to have been embraced by major institutional investors, suggesting the strategy is poised to enter a golden age as investors confront negative interest rates, and extraordinary low rates. In recent sessions, when the stock market seemed poised to suffer acute declines due to the pending impeachment proceedings against President Donald Trump, the cash-secured put sale strategy exploded in popularity.
Rather than selling stocks, or even buying defensive puts to protect stocks, which is what one would normally expect during a sharp decline, some investors sold puts, often in very large sizes. Major investors—and that is the only type of investor who could afford to trade puts that represent tens of thousands of shares of stock—often just focus on buying stocks. They rarely sell large amounts of puts as a way to control equities.
This reflects a historical mistrust of options, concerns about options liquidity, and a broad stock-centric bias that exists in the institutional money management industry. Those biases, however, have been eroding in recent years and they now seem poised fade as all investors are now increasingly confronting a world in which it is hard to generate meaningful investment yields without taking on significant risks.
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The big put sale trades, which Chris Jacobsosn, a Susquehanna Financial Group strategist notified his clients about, should thus be viewed as a sign that the humble cash-secured put strategy is no longer a secret of well-heeled individual investors with the resources and smarts to determine their own outcomes. Now, it seems the strategy is poised to grow in use and importance at a time of extraordinary singularity in the markets, economy and Washington.
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