Popular Option Strategies for Premium Generation

If you have ever traded options you will be familiar with buying and selling Calls or puts, however there are some relatively simple strategies that involve selling premium, such as; writing call options against shares in their portfolio (Covered call writing), writing cash secured puts or selling credits spreads.

Covered call writing is popular with investors that already own the underlying shares whether they are investors who own the stock and are looking to sell or those that own the stock and who do not want to sell but want to use it as a means of generating premium income. Returns will vary subject to the frequency, and the strike price, at which call options are sold. Investors who are looking to buy into a stock also use covered calls to effectively lower the purchase price.

Whilst an investor should never purchase stock solely to enter the 'options writing business' there are good returns available, especially if the shares are purchased on margin, however the underlying share price is all important and a big fall can instantly negate any profits. Additionally writing calls options is not a substitute for buying put options as the premium received is usually only a fraction of the share price. Therefore, Covered Call writing should be viewed in its correct context. On stocks that move up or are stable it improves returns. Stocks should be able to hold their own in a portfolio regardless of whether covered calls are sold, instead of being there just because options premiums on the stock are attractive.

For a more detailed overview of covered calls please click here

For a practical example of writing a covered call please click here

If an investor is looking to sell his stock, covered call writing allows him to set a minimum sale price. Many option writers start selling covered calls against their portfolio. Once they are used to the concept of managing the process they may decide to investigate getting paid a premium to buy shares.? Cash secured put writing can be thought of as a 'good till cancelled' buy order where a premium is payed by the seller of the shares.

How can an experienced trader make use of the premium selling on options:

A trader looks for a stock in which they would like to purchase 2,000 shares. They then sell a cash secured put. If the put expires out of the money then another is sold until eventually the Put is assigned. At this point the trader holds 1000 shares. If he/she is still bullish on the underlying stock another put can be written (for another1000 shares). At the same time the put is sold a call is sold at the same strike call on a covered basis against the original 1000 shares. If the stock falls the put is assigned and the 2nd 1000 shares purchased completing the investors buy order.

Covered call can be written against the 2000 shares with the trader's market outlook determining the assigned strike price and expiry. Once assigned on the calls the investor sells their 2000 shares. Depending on their outlook at this point they can either repeat the process or look at doing the same on another stock. 

Problems arise with both strategies when the original intention is overlooked. If the covered call writer is no longer prepared to let the stock go they are in effect writing uncovered calls (naked) using the stock simply as collateral cover for the option. The same is true with cash secured put writing where cash is the cover although the writer never actually want to buy the stock. Writing puts on stocks for the sake of earning an attractive premium, makes little sense if the writer doesn't want to eventually own the underlying stock. As long as the purpose of these two fundamental strategies is not forgotten both strategies can add considerably to returns.

Please click here for some traps to be aware of when writing covered calls.