Selling options enables an investor to trade different premium values above or below the current stock price for profit, as opposed to having to actually purchase shares of stock and trade them at their market price, thus providing them with the potential for greater percentage returns.
How Do You Sell Premiums?
Premiums are based on two option values, the intrinsic value, which is the real value at expiration, and the extrinsic value, which, in short, is simply how close the options speculation is to the actual stock price at expiration.
For calls, strikes, or the price that an investor chooses to buy or sell shares, that are lower than the stock price at expiration have intrinsic value, and puts that have a stirk price higher than the stock price at expiration have intrinsic value.
However, all options have some sort of extrinsic value, which is how much the stock price will go up or down in the time left until the option expires.
Options also differ from publicly traded stock in that they have expirations, whereas stock does not. The expiration is the date that all option trading stops and contracts become due or worthless, and it can be the standard monthly expiration or a weekly expiration, which usually provides less liquidity.
At expiration, call options that are below the stock price and put options that are above the stock price will result in a profit. Otherwise, put options that are below the stock price and call options that are above the stock price at expiration will become worthless.
How it Works.
In general, to be in the money (ITM), or to benefit from the option premium, for calls, which is the option to sell shares at a discount, the strike price needs to be lower than the current stock price. On the other hand, for puts, which is the option to sell stock shares at a higher price, the strike price needs to be above the stock price.
For instance, for calls, if at expiration the stock price is $70, and the investor owns a call option at $60, the investor can purchase 200 shares of stock for $60, even though the price of the stock is $70, which means the call option has an intrinsic value of $10 per share, and thus, is in the money.
Meanwhile, out of the money options means at the time of expiration, the option is higher or lower than the stock price, which means it has no intrinsic value, so it is worthless.
As an options seller, the goal is to sell the option for a certain value prior to it
expiring so that when it stops trading, it has no intrinsic value, and the investment collected at the beginning can be regarded as a profit.
Selling options for income can be pretty simple, with the right understanding, and it can be highly profitable. In fact, according to Tastytrade, “learning about options trading can be pretty simple if you just remember the factors that contribute to their intrinsic and extrinsic values.”