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Selling cash secured puts and covered calls for income
Option selling is a great way to boost your gains and can be significantly less risky than going long or short stocks and options directly.When you sell an option you are paid a premium to take a risk. When you sell a PUT you risk having to purchase shares at a given strike. When you sell a CALL you risk having to sell shares at a given strike.
Terms to understand
- Option: Gives the buyer the right to buy or sell 100 shares of a given stock at a given price (strike) and date (expiration). The buyer pays a premium for that right and the seller collects the premium from the buyer.
- Cash secured put: A put option that you sell to open a trade. On the option expiration date if the stock price is less than your strike you are obligated to buy 100 shares for each sold option at the strike price. It is called "cash secured" because you need to have enough cash in your account to cover the purchase of the shares.
- Covered call: A call option that you sell to open a trade. On the option expiration date if the stock price is greater than your strike you are obligated to sell 100 shares for each sold option at the strike price. It is called a "covered call" because you need to own enough of shares to be able to cover the calls you sold. If you sell 1 call you need to have a minimum of 100 shares of the underlying stock.
- Strike: The price the stock has to be above or below for the option to have any value at expiration. Option sellers want their sold options to go to $0 so they can collect all of the premium for selling the option. A put goes to $0 if the stock finishes above the strike at expiration and a call goes to $0 if the stock price finishes below the strike at expiration.
- Expiration: The date an option expires and will either be worthless (if it's OTM) or have value (if it's ITM) and can be exercised by the buyer of the option. A call option that is exercised will force the seller to sell their shares at the strike price. A put option that is exercised will force the seller to buy shares at the strike.
- Out of the money (OTM): For a put option this means the stock price is currently above your strike. On a call option the stock price would be below your strike. When selling options we want our option to be OTM so we are not assigned.
- In the money (ITM): A put option is in the money if the stock price is below the strike and a call option is ITM if the stock price is above the strike.
Cash Secured Put
Let's say you want to sell a cash secured put on NVDA. This means by the expiration date if the price of NVDA is below the put strike price (ITM) you would have to purchase 100 shares of NVDA for each option contract sold at that strike. 1 option contract represents 100 shares of the underlying stock. You are selling a put which is covered by cash in your account if you have to buy the shares.Have a look at the following chart from optionstrat.com. This shows you are paid $748 for the risk of having to buy 100 shares of NVDA at $275 if the stock price is below your strike of $275 on 4/8. So even if NVDA drops to $200 you still have to pay $275. Which is the same risk as buying the shares outright except you were paid $748 to do it, so you have some room for error to the downside. You can also pick a strike further away from the current stock price (further out of the money) which would lower your credit but also lower your risk.
You can search for the best ROI for selling puts across all expirations and strikes on NVDA here at optionsellerroi.com
The same theory applies to selling calls where you would buy a call further away from the strike price than the call you sold.
Covered Call
Now lets say you already own 100 shares of NVDA (or you are long a call option) and you want to sell a call against that position to make some extra money from it. This is called a covered call because you are selling an option against a position you already own.
In this case if the price of NVDA was above your strike at expiration you would have to sell your shares at the strike price. So if you sold a call from NVDA at a strike of $285 and the stock rose to $300 at expiration you would have to sell your shares at $285 losing $15 of upside gains. That isn't great but also not bad because you made money on the rise of the stock price as well as the premium you were paid.
Here you are paid a premium of $440 representing your immediate credit for selling the option. As the stock goes up you continue to profit until you reach the 285 strike price because at that price you have to sell the shares at expiration.
You can search for the best ROI for selling covered calls across all expirations and strikes on NVDA here at optionsellerroi.com
Credit Spread
There are ways to limit your max loss when selling options by using credit spreads. A credit spread is adding a long call or put (option you purchase) further away from the stock price than the short put (option you sold for a premium).
Looking back at the cash secured put example we can see how adding a long put at a strike below the short put lowers our premium collected but also drastically lowers our risk.
Now the premium we collect is $574 instead of $748 but our max loss is $1,426 vs $26,752! It's not realistic to think that NVDA is going to $0 to realize the full loss of $26k but you can see how the long put helps reduce our risk.
I encourage you to go to optionstrat.com to play around with these ideas and see how changing the days left until expiration, and option choices changes the credit and max loss.
In the next article we'll discuss how optionsellerroi.com makes selling options much easier and more profitable. Feel free to contact me on twitter @optionsellerroi if you have any questions