What is options trading - What are the benefits of writing an option?

Written by
Bence András R.
Fact checked by
Adam N.
Apr 2024
What is options trading - What are the benefits of writing an option?

This is where options get tricky. Understanding how writing (selling) options work is equally important as buying options contracts.

In this article, we'll continue to explore this topic with the help of Chris Douthit from Options Strategies Insider, who was kind enough to share his knowledge on this topic.  

The benefits of writing an option

"By writing options contracts (selling options), investors put the advantage of time on their side. When you buy options, you not only have to be in the right direction, but the stock has to move fast enough and get to profitability before the options expire. For every day the stock doesn't move in your favor, you lose money. When you sell options, you simultaneously collect cash while giving yourself a high probability of success. Even if the stock moves against you, it's a winning trade if it doesn't reach the strike price by expiration."

Let's see an example

"For example, you've done your research, and you think stock ABC, which is currently trading $100, is a strong investment. You could buy the stock, you could buy call options, or you could sell put options.You could decide to buy the 105-strike price call option going 60-days out for a price of $6.00. That means the stock not only has to get the $105 before you start making any money, but you also have to make up for the $6.00 premium you paid for the position. Here the stock would have to get to $111 before you turn a profit. You'd be fighting an uphill battle the whole way.

You could also decide to buy the stock itself by paying $100 a share, but this can get expensive very quickly. Plus, if the stock trades down, you start losing money right away.

Another option would be to sell a 90-strike price put going 30-days out for $4.00. As long as the stock doesn't trade below $90 within the next 30 days, that $4.00 will be profit. That means if the stock trades higher, you win. If the stock trades sideways, you win, or if you get the direction wrong and the stock trades down into the low 90s, you still win.

If the stock were to trade below $90, you would be forced to buy the stock at that price, but you wanted to own ABC stock anyway, and because you sold puts instead of buying the stock at $100, now you're being forced to buy it at 10% discount compared to where you initially wanted to purchase it. Plus, because you were paid a $4.00 premium when you open the trade, your adjusted cost basis would be $86, which is actually 14% cheaper than where you would've purchased the stock 30-days earlier."

A wrap-up

"You can see why selling option premium is such a powerful tool used by the world's smartest investors. Collecting a small premium month after month may not seem like a lot of money when you look at just one trade, but we do this every month, collecting many premiums, only buying on discounts, the profits start to add up rather quickly."

Where to look for more?

Hope you liked this guest post from  Chris Douthit from Options Strategies Insider of the benefits of selling options. If you'd like to go deeper, navigate to one of the articles below:

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Bence András Rózsa
Author of this article
Bence is a former broker analyst for BrokerChooser. Having an MSc in international economy and finance, he focused on equities, cryptos and newcomer financial services. He also gained years of experience within the brokerage industry, specializing in stock and CFD/forex brokers, crypto providers and robo-advisors.
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