Let's face it, Options are not for everyone. Many investors feel that there is some heightened risk that is taken when using options and that is simply not true.
When you are ready to use options, you do have to realize that there will be a learning curve so, just like anything else, have a bit of patience. Take some time to learn before you trade, and make an effort to understand how options work. Options are not stocks and it's important to understand that there are some real differences.
When you do embark on the world of options I always suggest that investors start with covered calls. If you are an investor who has experience buying and selling stocks, then making the transition to writing covered calls should be very easy. Why? Because this option strategy begins with the purchase of stock, and you are already familiar with that process and the decisions required. Also, there is no additional risk so you don't have to worry about blowing an account with a covered call.
Writing covered calls is neither the best nor safest strategy available, but it's safer than owning stocks outright and it gives you experience using options. Here are three reasons why writing covered calls is my top pick as an introduction to the world of options:
1). It's an easy to understand strategy.
- You sell someone else the right to buy your stock at a specified price (strike price)
- You collect cash for making that sale
- The agreement has a limited lifetime
- If the other person declines to buy your stock by the deadline, the agreement expires. That means you are no longer obligated to sell your shares.
2. Covered calls provide limited protection against loss if the market declines.
- By collecting cash, you effectively reduce your cost basis for the stock.
- By reducing your cost basis you are reducing your risk as well.
3. Covered calls lead to many more profitable trades when compared with buying stock.
- If the stock declines, you lose less than the person who did not write a covered call.
- If the stock declines by less than the premium you collected, you earn a profit.
- If the stock is relatively unchanged when expiration day arrives, you have a profit while the buy and hold investor breaks even.
- If the stock moves beyond the strike price by less than the premium collected, you earn more than the buy and hold investor.
- If the stock undergoes a significant price increase, that's the only scenario in which you earn less than the buy and hold investor
So the bottom line is that with a little bit of education, one can confidently add covered calls to their existing portfolio and increase their chance of profit, while reducing their risk... And there is no catch.. That's how it works!