There are many videos and articles out there explaining how buying options can be a quick way to turn a small amount of money into a 2x, 3x or even 10x return. What these videos don’t explain to you is that the chances of this occurring are very slim. In order for that kind of return to occur, there has to be a large move in the underlying stock one way or the other, that is much larger on magnitude than the expected move.
On the other hand, the less glamourous side of options trading, (although it is starting to see more popularity on youtube and other social media platforms), is selling options to generate weekly or monthly income. More specifically, selling options or selling option premium.
How does selling options work?
When you see people on wallstreetbets buying a large amount of call options or put options, trying to make Lamborghini money, there is always someone on the other side of the trade. In order for them to buy these options, someone has to be willing to sell it to them.
Why should I sell options?
Selling out of the money options gives you the most chance for profitability. Example: Stock ABC is currently selling for $10 / share so you decide to sell a $9 put option with expiration in 30 days. Selling a $9 put option means that if the stock price drops below $9 by the expiration day, you agree to purchase 100 shares of stock at $9 ($9 x 100 = $900).
The important thing to grasp is that in the example above, you will make money if the stock stays the same and hovers around $10 at the expiration date. You will also make money if the stock goes up. Even if the stock goes down to $9.01 on the day of expiration, you will keep the entire premium that you received when you sold the put.
Based on the made up delta of 30, this means that on average, you will make money 70% of the time.
The example above is an example of selling an out of the money put.
The same applies to selling out of the money calls. Example: Stock ABC is currently selling for $10 / share so you decide to sell an $11 call option with expiration in 30 days. Selling an $11 option means that if the stock price rises to $11 by the expiration day, you agree to sell 100 shares of stock at $11 ($11 x 100 = $1100).
Similar to the put example, if the value of the option goes down, stays the same or even rises (but stays under $11), you will keep the entire amount of premium received when you sold the option.
What are the downsides to selling options?
As you can see, selling out of the money options is a great way to put the favor on your side. You have a greater chance of winning on the trade, but it also comes with some downsides.
In the put example I described above, if the stock price falls way below your strike price, you could be in for a very big loss. If for example, the stock drops to $5 at expiration, since you agreed to purchase 100 shares at $9 ($900), with the current stock price of $5 ($500), you have just lost $400.
As with any type of investing, there is some risk involved, but considering this is one of the only types of investing where the odds are on your side, it makes a for a very compelling way to generate weekly or monthly income.