Learn to Trade Options: Simple Call and Put Selling

Breaking down basic option selling with options guru, Bernie Schaeffer

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    Trading options can be a complicated process as a lot of options strategies are available and traders need to evaluate all of the possible routes ahead of executing a trade. As such, Schaeffer's are starting a new educational series titled Optimizing Your Options Strategies. The beauty of options trading is that there are options strategies for every market environment. In this series, we will cover all available options strategies for an educated trader to consider when identifying trading opportunities.

    In this article, we will be talking about one of the most popular options strategies known as Short Calls and Puts (or Premium Selling). Selling calls and puts is a popular options strategy in which the trader is betting that the price of the underlying stock is going to go against the direction of the options. When playing a short call option, the stock price needs to go down and for playing a short put option, the price needs go up to close out in profit territory. An option is a depreciating asset and, therefore, shorting options helps from that aspect because the trader is not going against the nature of the options contract.

    The potential profit when utilizing a premium selling options strategy is limited to the premium, minus the commissions paid, received in both the short call and the short put, and this is the acquired profit if the options expire worthless, or out-of-the-money (OTM). Theoretically, the risk posed by shorting options is unlimited due to the unlimited profit potential of buying an option. The underlying stock can go to zero, or increase over 100%. To reduce this risk, traders should avoid shorting naked calls or puts. The breakeven price when utilizing a premium selling options strategy is the stock price minus the premium in case of shorting put and the stock price plus the premium received in case of shorting call.

    What Does it Mean to Sell a Call?

    A short call options strategy is one options strategy that allows traders to take a bearish position. It involves selling call options because calls give the holder the right to buy an underlying asset at a specified price.

    If the price of the underlying asset falls, a short call option strategy profits. If the price rises, the short call option strategy losses but due to the nature of the call (unlimited profit potential), there is unlimited exposure during the length of time till expiration.

    To limit losses, most of the traders will exercise a short call while owning the underlying asset known as covered call or they use some other option strategies like credit spreads and debit spreads to limit risk.

    What Does it Mean to Sell a Put?

    A short put options strategy is one of the ways to take a bullish position. It involves selling put options because puts give the holder the right to sell an underlying asset at a specified price.

    If the price of the underlying asset rises, a short put option strategy profits. If the price falls, the short put option strategy losses but due to the nature of put (unlimited profit potential), there is unlimited exposure during the length of time till expiration.

    To limit losses, most of the traders will exercise a short put using some other option strategies like credit spreads and debit spreads to limit risk.

     

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