Options are one the most versatile financial instruments at your disposal. Options can be used to trade market direction, to trade volatility or to hedge a position in the underlying instrument.
One of the most popular uses for options is income generation.
Here are 7 ways to potentially generate income using options:
- Covered call writing: If you own 100 shares of stock ABC, you can write a covered call against your position. Covered calls can not only potentially generate additional income, but may also provide a degree of downside protection.
- Cash secured put writing: Writing put options on a stock you wouldn’t mind owning anyway can be a great way to potentially generate income. If you wouldn’t mind owning shares of XYZ at $40, you can sell a $40 put (with enough cash in your account). If the stock stays above $40 at expiration, you keep the premium collected. If it falls below $40, you will be assigned a long stock position at $40.
- Iron condors: See a market that is stuck in a trading range? Why not try to capitalize on it? An iron condor is a limited risk short premium position that may potentially generate income if the underlying stays within a defined range. The iron condor consists of a short call spread and a short put spread.
- Call or put credit spreads: Think the SPX has reached a long-term top? You could consider selling a call credit spread. A call credit spread can potentially generate income if the underlying remains below the short call strike at expiration.
- Using a ratio spread: Do you think stock ABC may move from $50 to $55 over the next few weeks but no higher? You could consider a ratio spread. This option play involves buying a call that is closer to the money and selling two calls further out of the money. If put on for a net credit, you can potentially profit even if all options expire worthless.
- Iron butterflies: If you think shares of stock BBB are likely to stay right around $40 per share, you may consider selling an iron butterfly. This involves selling an at the money call and put and purchasing an out of the money call or put (the wings).
- Sell elevated IV: When options are trading at the top end of their IV ranges, perhaps at the highest levels over a 12-month period, you may consider selling options or options spreads. IV tends to be mean-reverting and a decline in IV can potentially generate income as option values deflate.
Options can be used in many different ways to potentially generate income. It is important to keep in mind, however, that naked option selling carries unlimited risk and is not suitable for all investors. Credit spreads may be a good choice as they have defined risk and can be constructed based on your risk tolerance and trade objectives.
