Much of the conversation of options trading is in regards to buying contracts – but maybe you want to take the wheel yourself and learn how to sell stock options. If so, you’ve come o the right place. In this article, we’re going to guide you through the process of creating and selling your own options contracts.
While there are obvious benefits to buying puts and calls, it’s been said that the real advantage belongs to the seller of options contracts – at least from a probability standpoint.
We’ll explain why that is, and talk about the potential downside to selling options contracts as well. By the time you finish reading this article, you’ll have a solid understanding of whether this strategy has a place in your trading style and how to set yourself up for success along the way. Let’s start with a quick introduction to selling options.
How Selling Stock Options Works: A Brief Overview With Pros & Cons
What is the benefit of knowing how to sell stock options? After all, it’s much easier to play the other role and simply purchase stock options contracts. However, the relationship between time decay and intrinsic value benefits the seller of options contracts greatly.
Before we get into the upside and downside from the seller’s standpoint, let’s talk about what this process looks like in reality:
A Brief Overview of Selling Options Contracts
First, let’s talk about how you stand to make money as the seller of options contracts: from the premium paid by buyers. That’s it. You earn income from the sale of your contract – and from there, it’s a matter of waiting to see what happens and hoping for the best.
Because as you may already know based on how stock options work, the buyer is expecting their contract to be in the money. And if that happens, they’ll exercise the option – at which point you have the obligation to either buy/sell the underlying stock in question to fulfill your buyer’s order.
Obviously, as the seller of an options contract, you are hoping that this does not happen – and that the contract expires worthless. Otherwise, you stand to take a serious loss as the premium you earn will not outweigh the cost of fulfilling that order. We’ll talk more about the downside/risk of selling options in a moment. First, let’s cover the benefits.
Benefits of Selling Options
There are a few advantages you have as an options seller. For one, selling options is one of the simplest ways to create consistent income without exposing yourself to many risks. While the profits you’ll earn as an options writer are quite low, so is your downside (at least, if you are good at what you do!). In comparing this strategy to the other common trading styles, it’s clear to see that you have a higher probability of profit as an options seller.
But beyond helping you generate small, consistent profits in the here and now, selling options is a great way to hedge against a position you already have open in stock. This can help you minimize losses or protect income while enjoying peace of mind.
The Risk of Selling Options
The most obvious downside to selling options is the little room for profits. You only earn a premium on the contracts you sell, which is rarely an impressive amount. And as you’ll see below, the wins are small but the losses can be devastating.
As an options seller, it’s generally accepted that the odds are in your favor. As each day passes and the stock option expiration date gets closer, time decay eats away at the value of that contract. This decreases the likelihood that the contract will be considered “in the money” and end up getting exercised.
But, what if you make a miscalculation or use poor judgment in writing your contract and things don’t work out how you’d hoped? In theory, your loss could be unlimited. Let’s say you sold call options for stock XYZ at a strike price of $10 – and within a few months, that stock has doubled in price. When the buyer of your contract exercises the right to buy those $20 shares at a discount of $10, you take a steep loss.
This risk can deter more conservative investors from selling options – and rightfully so. You’ll have to consider your risk tolerance and determine what sort of losses you’re comfortable taking in a worst-case scenario. With that said, the advice we’ll offer below will help you minimize your risk while maximizing profit. Let’s talk about how to sell stock options.
How to Sell Stock Options: Beginner’s Guide to Writing Your First Contract
Ready to learn how to sell stock options? While this strategy may seem complex and overwhelming, it’s actually pretty straightforward in theory. The hard part is consistently writing contracts that expire worthless – so you can avoid paying costly losses. With the right strategy and a bit of help from reliable software, though, you can set yourself up for easy success. First things first – let’s talk about the different types of options you can sell.
The Different Types of Options You Can Sell
At the most basic level, there are two types of options contracts:
- Put options grant the holder the right (but not the obligation) to sell an underlying asset at a predetermined price, in predetermined quantities, before a predetermined date.
- Call options grant the holder the right (but not the obligation) to buy an underlying asset at a predetermined price, in predetermined quantities, before a predetermined date.
If we’re just talking about selling puts or calls, the strategy you’ll employ is simple. If you suspect a stock is going to remain stagnant or increase in price, you’d sell a put option. On the other hand, if you think a stock’s price is going to remain stagnant or drop in price, you’d sell a call option. The key is finding opportunities, taking a stance, and creating contracts accordingly. So let’s talk about choosing stocks for your options contract next.
Choose the Underlying Stock
This is the most critical element of being successful with any strategy – whether it be swing trading or options trading. You need to be able to consistently uncover stocks that align with your goals and accurately forecast how they’re going to move in the future – so that you know what type of contract to create and how to best configure the strike price and expiration date.
Now, you can use outdated tactics of analyzing a stock that force you to spend hours in front of a screen – or you can take a more simplified, modern approach to trading the stock market: investing in a reliable stock forecasting software like VectorVest.
Just as it can help you uncover swing trading stock picks, VectorVest can help you spot trends early which will prove invaluable in building your options contracts in a way that favors you – the seller. This eliminates much of the risk associated with selling options contracts while maximizing your upside potential.
The system doesn’t just increase your rate of success either – it also saves you time and stress throughout the process. You’re given all information you need in three simple ratings. And to make things even easier, VectorVest even gives you a clear buy, sell, or hold recommendation for any given stock, at any given time.
On days you’re not sure where to start, you can pull up the preconfigured stock screeners that help you find opportunities on autopilot that align with your trading strategy. Once you see how much easier and more profitable selling options is with the help of VectorVest, you’ll wish you’d found it sooner! Learn more about how to pick stock options in our blog or get a free stock analysis today to see the system in action. For now, let’s proceed to the next step in how to sell options.
Determine the Strike Price & Expiration Date
While picking the right stocks is undoubtedly key to creating favorable options contracts, the strike price and expiration date on your contracts influence your success rate as well.
And as you can imagine, the more you skew these two factors in your favor, the less you’ll be able to earn in premium. There’s a balance to be found here between managing risk from the seller’s point of view while still offering enough value that a buyer is interested in the first place.
Naked Options or Covered Options?
You should also take the time to determine whether you’re going to sell naked or covered options.
When you sell naked options, you don’t actually own the underlying stock in question – you go out and purchase/sell it when the buyer of the option decides to exercise the contract. This could lead to virtually unlimited losses. As such, it’s an inherently riskier approach to selling options contracts – and only recommended for advanced traders with a high-risk tolerance.
Covered options on the other hand are sold against an underlying asset that you already own. This helps reduce risk as you already own the stock at a known price point. That means when configuring the strike price/expiration date, you can be more calculated.
With that said, covered options are less profitable from the seller’s standpoint – which is the tradeoff you’ll need to consider. Do you want high risk and high upside potential? Sell naked options. Do you want to play it safe and potentially earn less profit? Sell covered options.
Create the Contract Through Your Brokerage
Once you’ve got the details of what type of contract you want to sell, it’s time to actually make it happen. You can write options contracts through most brokerages – and at that point, it’s just a matter of executing your plan and hoping the contracts you sold expire worthless. This allows you to collect premiums without having to fulfill any of the obligations set out in your contract should it end up in the money.
It’s important to analyze your risk-to-reward ratio when creating these contracts. Knowing your upside potential and downside potential helps you determine just how much sense your contract makes from your standpoint. And as you now know, VectorVest can help you find opportunities that align with your strategy so that you consistently sell contracts that stay out of the money.
Wrapping Up Our Guide on How to Sell Stock Options
That concludes our guide on how to sell stock options. While much of the information online is in regards to how to buy stock options – that’s just one way for you to earn income or hedge risk through this strategy.
Sure, selling options contracts isn’t nearly as exciting or lucrative as participating as a buyer – but it’s a more consistent, stress-free approach to trading the stock market. And if you’re an experienced trader looking for a more predictable source of income, this might be the perfect strategy for you.
If you want to learn more about trading options for beginners and how stock options work, explore our blog. We have in-depth resources on how to learn stock options trading, what happens when you exercise an option, taxes on options, swing trading options, and stock warrants vs options.
Otherwise, it’s time to take what you’ve learned today and start writing out your own options contracts! Just remember to set yourself up for success by leveraging the power of VectorVest’s stock forecasting system. Having insights into how a stock is going to move in the future will prove invaluable in creating favorable contracts that stay out of the money.