Options Income Strategies
November 10, 2022
Lyons Wealth understands that being an investor isn't just about the glitz and glamor -- it's about the constant hustle and overcoming various challenges, as well as navigating the risks. Investors have to look at daily numbers and calculations to make the best decisions with their stock positions, all while acknowledging that the market can have its highs and its deepest lows.
Lyons Wealth Management specializes in guiding investors and generating the best advice when understanding their stock. Through its multiple strategies in place, you'll know the best way to put your investment and grow your wealth.
One of those ways is Options Trading. This method gives traders an idea of the direction of the stock market by providing them with a choice to buy or sell assets within a specified timeframe and a specified amount. Like other strategies, options trading consists of huge risks, but the rewards are worth it, especially if you've got the experience in your belt.
Lyons Wealth uses various strategies to help traders generate income and reach their financial goals. In this article, you'll learn about each income strategy and how they are currently used in today's market industry.
What are Options Income Strategies?
Investors are able to earn income through the use of option income methods, which may involve less risk or more lucrative opportunities than the simple purchase of dividend-paying stocks.
Possibly, the underlying stock could change in such a way that triggers the exercise of an option. If this happens, the trader could suffer a loss or be forced to sell or buy an asset against their choice.
Before incorporating option strategies into their portfolios, investors should priForitise properly understanding these strategies and spend the necessary time doing so. Likewise, they may also want to discuss these strategies with their financial advisor.
There are two primary categories that can be employed in your strategies - credit spreads and debit spreads.
With a credit spread, the investor purchases a call or put option while simultaneously selling another option on the same underlying asset. The two options have different strike prices but the same expiration date. This strategy is popular because the premium from the sold option offsets some of the cost of purchasing the other option.
A debit spread is less common and involves buying a call or put while simultaneously selling additional calls or puts. This creates a net loss on strike prices, as the premium earned from the sale is less than the amount disbursed for the purchase. Some traders use debit spreads in order to speculate on price movements or generate income from volatility.
Both credit and debit spreads can be used to generate income, but it's important to understand how each one works before entering into any options trade.
Options Strategies to Know
Now that we 've looked at the basics of options income strategy, let's take a closer look at some specific methods that can be used to generate income and grow your portfolio
A covered call is a strategy that can be used to protect against the risk of holding a long position. A covered call involves the purchase of shares of a stock, followed by the sale of a call option on those shares. The trader keeps the option premium of the current stock price from the sale of the call option regardless of what happens afterwards.
For example, suppose John purchases 100 shares of Apple stock for $500 each. The current stock price is $550 per share, and the options premium is $5 per share. He writes a covered call with the same strike price and expiration date. Now, if Apple's stock price decreases to $525, John can still sell his shares for $550 because he has already sold the call option. His profit would be $25 per share, or $2,500.
If the price increases above $550, he may have to sell his shares at that price if the owner of the options contract decides to exercise their right to buy. In this case, his profit would be limited to the premium paid plus any dividends received while holding the stock and fewer commissions paid to buy and sell the options contracts.
There are both positive and negative aspects to writing covered calls. On the one hand, this method might be able to help compensate for losses incurred if the stock price lowers. On the other side, if the owner of the options contract decides to exercise their right to buy, the trader might be forced to sell their shares at a price lower than they would have liked.
To implement this strategy, the trader must select a stock price and a strike price for the call option they will sell. The strike price should equal or exceed the current strike price. The option premium is the amount of money the trader will receive from selling the call option. The trader can keep this premium regardless of what happens with the stock price after that.
Bull Call Spread
A bull call spread is a vertical spread strategy that involves purchasing call options at a lower strike price and the simultaneous sale of call options at a higher strike price. This strategy is employed when an investor anticipates only a slight increase in the value of the underlying asset. The key advantage of this tactic is that it limits both the potential profit on the trade and the amount of premium that must be paid.
There are two types of bull call spreads call and put:
Call vertical bull spread
This involves buying and selling call options with the same underlying asset and expiration date but different strike prices. If the price increases as expected, the trader will profit from the increase in value of their purchased call option. On the other hand, if there is no significant change in stock price or it decreases, they can still lose money on this trade because they must purchase the call option at a higher price.
Put vertical bull spread
This strategy is similar to the call vertical spread, but instead of buying and selling calls, it involves collecting option premiums and profiting from the decay and decrease of the option's value over time. The trader will purchase a put option with a lower strike price and sell another one at a higher strike price with the same expiration date.
Bull call spreads typically have a timeframe of one to three months, although they can be held for longer periods if desired. The trade will generally expire worthless in the event that the underlying asset does not increase in value enough to offset the cost of the premium. However, if the asset does increase in value by enough, then the trade can result in a profit equal to the difference between the strike prices multiplied by the number of contracts traded.
Bear Put Spread
Another form of the vertical spread is known as the bear put spread. In this trading strategy, the investor buys put options at a certain strike price and sells the same amount of put at a lower strike price.
Both of these transactions take place simultaneously. Likewise, both options are bought for the same underlying asset and have the same date on which they will expire.
A trader will employ this approach when they have a pessimistic outlook on the underlying asset and believe that the price of the asset will go down in the near future. The strategy has a low potential for both restricted gains and limited losses.
For example, if you purchase a put option at $42 that expires in June and sell the same amount of puts at $40.00 with the same expiration date, you can collect some premium for selling the option to open the position. If the price of XYZ stock goes down before expiration, your losses will be limited to the $2 difference between strike prices, multiplied by a maximum of 100 shares and your premium income.
On the other hand, if XYZ stock increases in price, then you risk losing more than you gain from buying the put options below market value. In this scenario, it may be better to sell put options at higher strike prices instead and take the premium income. However, keep in mind that with each higher strike price comes a smaller premium, so the amount of income may be reduced.
As with any investment strategy, weighing the risks and rewards is important before deciding if this approach is right for you.
When investors purchase an asset, like shares in a stock, in addition to buying put options for a similar number of shares, they are engaging in what is known as a married put strategy. A put option gives the holder the right to sell an asset at a predetermined price, called the strike price. So, if the stock's price falls below the strike price, the investor can still sell it at that price and avoid losses. One hundred shares of stock are equivalent to one single put contract.
Some investors use puts as insurance against potential losses they could incur due to holding a certain stock.
For example, if you purchased 100 shares of XYZ stock at $50 per share and out-of-the-money puts with a strike price of $45 for those same shares, your maximum loss would be limited to $5 per share, or $500 total.
Puts can also be used to generate income. To do this, investors sell puts over time, confident that the underlying stock will not fall below the strike price during that time frame.
And finally, investors may also write puts at-the-money or out-of-the-money, hoping that the option expires worthless so they can keep the entire premium received when selling the put. This is more speculative and may not be suitable for all investors. Selling puts has become increasingly popular over the past decade as online brokerages have made it easier for individual investors to access this investment strategy.
A protective collar is an options strategy that involves holding a stock, selling a covered call, and buying a put option. This strategy is often used by investors who want to protect themselves against a dip in the stock price. Protective collars are typically associated with a very low risk and low volatility.
One way to make money from a protective collar is to sell the call option for a price that is higher than the price you paid for the put option. Even if there is no movement in stock prices, you could still make a small profit if the stock price doesn't move very much over the course of the year.
Protective collars have been around for over a decade and are often used by investors who are looking for a low-risk options strategy.
Long Straddle and Long Strangle Strategy
A long straddle and a long strangle are two similar options trading strategies. Both involve the purchase of an at-the-money call option and a put option with the same expiration date and underlying asset. The difference is that with a long straddle, the call option's strike price is equal to the put option's strike price and is unsure of the market's direction. With a long strangle, the call option's strike price is higher than the put option's strike andwe hope that a large movement in the market will result in a profit.
A long straddle is typically used when an investor has a strong opinion about the underlying stocks but isn't sure how it will move. For example, if you believe there is going to be a major movement in the stock price but aren't sure whether it will go up or down, then a long straddle could be a good option.
The long strangle is typically used by investors expecting big market movements but unsure of which direction it will move in. For example, if you believe that an important news announcement or economic event could impact the overall stock market, then a long strangle could be worth considering.
Both strategies are fairly risky, so weighing the potential risks and rewards before deciding if one is right for your investment strategy is important.
Strangle Options Strategy
A strangle option is a type of options strategies that are used when the direction in which an underlying asset will move is known in advance. Purchasing a call option and a put option on the same asset is required to complete this strategy. These assets will become worthless on the same date in the future.
The cost of the premiums that must be paid for both options contracts represents the potential risk posed by a strangle.
Because you have to pay them upfront, you will be in the negative if neither of the strike prices is reached or if there is not enough of a difference to offset the cost of the premium.
Long stock investors should consider these strategies if they are looking to mitigate risk, protect their profits, or generate additional income from their stock. Additionally, they should weigh the potential risks and rewards before deciding if one of these strategies is right for their investment. Ultimately, it will depend on your individual risk tolerance, investment goals, and market outlook.
If you're not sure where to start, working with a financial advisor or broker may be the best way to determine which strategy is right for your needs. Lyons Wealth Management can help you evaluate your portfolio and explore potential options that may be right for you. Contact us today to learn more about our services and get started on the path to financial success!
¹ This statement applies generally to initial purchases of a position. Additional shares of a particular stock purchased at subsequent quarterly rebalances may still remain in short-term holding status (owned for less than one year) at the time of this publication.
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