So in my previous post, I detailed that I had started to experiment with Options Trading. None of this is advice, but just a description of my experience and thinking. I think that this was an interesting part of my experience in the past year because I didn't previously understand the appeal of some of the more complicated parts of the financial system despite being interested in it for a very long time.
In the past few months, I've begun to take additional opportunities when I can with the shares that I own free and clear via covered calls. I've heard about this option more and I encourage people to read about it more if they are interested. However, this strategy works well for me. In my case, I own a large number of shares in my trading account of certain stocks or ETFs.
It is my intention to buy more if we ever see a market drop. That said, I certainly don't intend to sell. Even in a crazy, 80% style drop like the great depression. I'm holding to zero. It's an extreme point of view. But for what I am going to describe, that is the standpoint where I think it makes sense.
Put simply, if I have 100 shares of stock ABC, and it is priced at 50 bucks, you might be willing to buy the right to get those shares at a higher price in the future, say 55 bucks within the next 30 days. What does this mean? It would be valuable for you if you managed money and you were believing that the stock would be going down. Why? Well, if your primary bet was that ABC sucked and it would tank, then you might be shorting it. In that case, you borrowed the stock and sold it at 50. You're betting it goes down, say to 45 and you can buy it back cheap and pocket the difference, 5 bucks a share.
What happens for sophisticated traders though, is that they sometimes see value in having insurance. In the scenario above, on ABC, they might want to minimize the downside. What if instead of going down as the other person thinks? Instead ABC spikes to 60. Now that person is hosed. They get called and have to pay 60 bucks a share, losing 10 bucks on each share.
Here's where the call comes in: They're sophisticated and know that sometimes things happen that are not as expected. So, they buy a call at 55. That means, in the bad case where it goes to 60, they still owe the difference, but they can recoup some of that by getting the shares from me at 55 instead of 60. A five dollar discount. Not bad right?
This is a great form of insurance for the other guy, but I'm giving something up here. Now, as a result of this, I lose all of the upside over 55 bucks. Why? Well, now he has the option to buy from me at this fixed price. So, for that option, I'm charging. Maybe 50 cents a share, maybe 2 bucks, or anything in between. Depending on the timeframe, the volatility of the stock and other factors, there is a market for these options.
What I like about this strategy though is simple: I'm not selling. And if you end up getting the stock from me at a higher price (we're selling calls that I have the shares for), then I still made some money: the fee of the option and the difference between the 50 and 55 in the example above. So, for options trading, I like this a fair bit. Of course, if the option is exercised, I'll sell my shares at that profit and I'm fine with it.
It's not the crazy you-only-live-once betting. Its just a few bucks usually. But, on a recurring basis, this can add up and I'm happy to get "paid to wait" while the stocks keep moving around while I have no intention of selling. If you're interested in options, I recommend you review educational materials, my broker provided some good information. It can really help make more sense of it. Have fun!
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