We have all heard that stock options are speculative instruments. It is true that they can be used, very effectively, for speculating. However, they can also be used in ways that produce profits on a consistent basis.
All option contracts expire. This is a certainty. In fact, not only do we know that they will expire but we also no precisely when they will expire. The only question we cannot answer ahead of time is whether the underlying stock price will be above or below the options strike price.
The strike price is that price at which, in the case of a call option, the option holder may purchase or, in the case of a put option, sell the underlying stock. If you own a call option, you would have the ability to buy the stock at the strike price. If the stock is trading at a price level higher than the strike price your call option will allow you to purchase the stock at the lower strike price.
What this also means is that if you sold that same call option, your option would expire worthless so long as the stock price remains below the level of the strike price. Conversely, a put option allows the buyer of that option to sell the underlying stock at the strike price, so if you sell a put option, your option will expire worthless so long as the stock price is above the level.
When you sell an option, you receive a cash payment to your account. You remain obligated to perform upon that short option until such time as it expires or you close the contract by repurchasing it. Because options expire on a known date, if you are able to identify a where a stock is likely to trade, or where it is not likely to trade, it may then be possible to sell call options above that range or put options below that range.
If you are correct in your assessment of the market, those options will expire worthless and you can keep the entirety of the premium that was paid into your account without further obligation. Selling options is not without its risks, but there are methods of curtailing those risks significantly.
One of the more favorite tools of sophisticated options sellers is the vertical credit spread. This involves that simultaneous purchase and sale of two options. The technique allows the option seller to still capture premium, but a cheaper option is purchased to limit the maximum risk. It is possible to limit your risk to less than $100 per trade.
Monthly premium income can be created in a safe, reliable manner by identifying key areas of support and resistance in the market. Selling stock options using a limited risk strategy, such as the vertical credit spread, preserves the high probability of success while also limiting the risk involved in an unexpected market move.
To learn more about vertical credit spreads, be sure to visit TheOptionClub.com and register for their free stock option trading lessons and newsletter.
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