Understanding 2 Important Options Strategies For Beginners

With the newfound hype revolving around options trading and multiple “get rich quick” schemes, many investors and traders are trying to hop onto this trend and make a quick buck. There are a plethora of options strategies for beginners as well as advanced traders.

Sadly, most investors and traders end up getting burnt due to a lack of experience and trading based on emotion and hearsay instead of applying known and proven option strategies. Previously, I shared The Ultimate Guide To Options 2021 so in this article, I’ll be diving deeper into options and specifically, the 2 important yet simple options strategies for beginners that are easy to implement and learn so without further delay, let’s get started.

Sell Covered Calls

Starting off with the first on my list of options strategies for beginners, selling covered calls. A covered call is when an investor is selling call options while owning an equivalent amount of the underlying security. To execute this, an investor holding a long position in a stock then writes (sells) call options on that same asset to generate an income stream through the premiums collected. The investor’s long position in the stock is the “cover” because it means the seller can deliver the shares if the buyer of the call option chooses to exercise.

Maximum Risks v. Maximum Reward

As you can see from the image above, if you were to sell 1 contract, the maximum reward you can get is capped at the premium you receive from the selling of the covered call. The maximum risk or loss is capped at the cost of the 100 shares you paid minus the premiums you received.

For example, if you were to own 100 shares of AAPL at an average cost price of $100 per share. If you were to sell a covered call option with a strike price of $110 and an expiry of 30 days, priced at $1 per share, or $100 for 1 contract, you will receive a premium of $100.

If the share price stays below $110, you stand to gain the maximum reward if you hold the option into expiry. If the share price goes above $110, you don’t make a direct loss per se, but rather, you can only make a maximum gain of $110-$100 (strike price – average cost price) + $1 (premium received), which is $11 per share.

On the other hand, using the same scenario, if you were to sell a covered call option with a strike price of $90 and an expiry of 30 days, priced at $2 per share, or $200 for 1 contract, you will receive a premium of $200.

If the share price stays below $90, you stand to gain the maximum reward if you hold the option into expiry. If the share price goes above $90, you will make a loss because, your overall profit and loss will come up to $90-$100 (strike price – average cost price) + $2 (premium received), which is a net loss of $8 per share.

When To Apply This Strategy?

An investor or trader can apply this strategy when they expect a minor increase or decrease in the underlying stock price for the duration of the written call option. If one were to expect a huge increase during the duration of the call option, selling covered calls might not be the best strategy as your gains are limited by the premium you receive and the difference between the strike price and your average cost per share. The investor or trader would be better off with just buying a normal call option to gain more exposure to the potential upside if their prediction is correct.

What Is This Strategy For?

This strategy allows an investor to achieve 2 key things:

1. Generate a stream of income (Through Premiums)
2. Lower their average cost per share

Firstly, the collection of premiums not only serves as a form of income but can also help lower your average cost per share each time you sell a covered call. When the strategy is done correctly and the right strike price is chosen, you can even guarantee a profit even when the option is exercised. This can be done by setting a strike price higher than your average cost per share.

This way, you can be guaranteed a profit when the option is exercised and you get to keep the premium should the option go unexercised at its expiry date.

Sell Cash-Secured Puts

The second on my list of options strategies for beginners, selling cash-secured puts. Selling a cash-secured put is similar to selling a regular, also known as a naked put, but the key difference is that you have sufficient capital to buy over the shares at the chosen strike price should the option become assigned.

Maximum Risks v. Maximum Reward

As you can see from the image above, if you were to sell 1 contract, the maximum reward you can get is capped at the premium you receive from the selling of the cash-secured puts. The maximum risk or loss is technically unlimited because you calculate it by taking the difference between the current share price and the strike price you paid plus the premiums you received, then multiply it by 100 because 1 options contract represents 100 shares.

For example, if you were to sell a cash-secured put for AAPL with a strike price of $100 and expiry of 30 days, priced at $1 per share, or $100 for 1 contract, you will receive a premium of $100. If the share price stays above $100, you stand to gain the maximum reward if you hold the option into expiry.

If the share price goes below $100, let’s say $95, you will make a loss because you have to buy the 100 shares of AAPL at $100 even though the share price has already gone below $100. On the bright side, your average cost per share is not $100 because you received a premium which can be used to lower your average cost down to $99 per share. This makes your overall loss $4 per share or $400 in total.

When To Apply This Strategy?

An investor or trader can apply this strategy when they have a long-term bullish opinion on the stock but do not want to buy the stock outright. If one were to apply this strategy, you have to be comfortable with the possibility that your option might get assigned, meaning you have to buy 100 shares at the chosen strike price. Typically, investors and traders choose stocks that they don’t mind holding for a longer period of time when applying this strategy.

What Is This Strategy For?

This strategy allows an investor to achieve 2 key things:

1. Generate a stream of income (Through Premiums)
2. Accumulate on a stock that they want to hold long term

Firstly, the collection of premiums not only serves as a form of income but can also help lower your average cost per share each time you sell a cash-secured put. In the case whereby you are assigned the 100 shares at a given strike, your actual cost per share is not the chosen strike price but rather, the strike price – the premium received. This allows you to actually accumulate the stock at a lower price than flat out buying it off the market.

Final Thoughts

In conclusion, these 2 options strategies for beginners might be simple to understand but, can definitely amass great wealth when applied correctly. These 2 strategies can even be used together in an advanced options strategy called “The Wheel Strategy” which I will be covering in the near future. Understanding more options strategies will allow an investor or trader to open up more doors for opportunities in all market conditions be it bull, bear, or even sideways.

For example, one can sell cash-secured puts on a stock they want to hold for the long term, 5-10 years out. As such, this strategy will allow them to not only collect premiums consistently but also, accumulate the stock at a cheaper cost price when they get assigned as compared to buying the stock directly off the market.