Frequently Asked Questions
WHAT IS OPTIONS SELLING?
Options selling is a strategy where an investor sells options contracts in exchange for receiving the premium paid by the buyer of the option. The seller takes on the obligation to fulfill the terms of the contract if the buyer chooses to exercise the option.
WHAT ARE THE RISKS OF OPTIONS SELLING?
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Unlimited Risk on Call Selling:
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Selling naked calls (calls without owning the underlying stock) exposes the seller to unlimited potential losses if the stock price rises significantly. This is because there's no cap on how high a stock can go, so the seller could face large losses if the price surges past the strike price.
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Significant Risk on Put Selling:
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Selling naked puts can expose the seller to substantial risk if the underlying stock price falls significantly. In the worst-case scenario, if the stock price falls to zero, the seller would have to buy the stock at the strike price, leading to a large loss (minus the premium received).
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Opportunity Cost:
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If the stock moves in favor of the buyer (for example, if a sold call option sees a sharp price increase), the seller may miss out on significant upside potential. This is a key reason why option selling is often more suitable for neutral or moderately bullish/bearish strategies rather than for aggressive, high-reward opportunities.
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WHY SELL OPTIONS?
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Collecting Premiums:
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When someone sells an option, they collect the premium upfront. This is the price the buyer pays for the right to exercise the option. If the option expires unexercised (i.e., out of the money), the seller keeps the entire premium as profit. This can create a steady income stream for the seller, especially if they sell options regularly.
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Profit from Time Decay:
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Options lose value as time passes, a phenomenon known as time decay. The closer an option gets to its expiration date, the less time there is for it to become profitable for the buyer, which can result in the option losing value. Sellers can profit from this time decay if the options they sell are unlikely to be exercised.
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Neutral to Bullish Outlook (for selling calls):
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When selling call options, the seller typically has a neutral-to-bullish outlook on the underlying asset. If the stock doesn't rise above the strike price, the option expires worthless, and the seller keeps the premium. The seller hopes that the stock won't go too high, making the option profitable for the buyer.
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Neutral to Bearish Outlook (for selling puts):
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When selling put options, the seller typically has a neutral-to-bearish outlook. If the stock price doesn't fall below the strike price, the option expires worthless, and the seller keeps the premium. In essence, the seller is willing to potentially buy the underlying stock at the strike price (if it falls below that price) but would prefer to keep the premium instead.
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Reduced Risk from Covered Positions:
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Some traders sell options as part of a covered strategy. For example, when selling covered calls, the seller owns the underlying stock and sells call options against it. The risk is limited because the seller already holds the stock, so if the call is exercised, they simply deliver the stock. This strategy can be used to generate additional income on a stock that the seller plans to hold.
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Enhanced Returns with Spreads:
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In more advanced strategies, traders may sell options as part of spreads (e.g., vertical spreads, iron condors, etc.). By combining the sale of one option with the purchase of another, traders can limit their risk while still generating income. This can be used to enhance returns in a market that is expected to remain within a certain range.
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WHY SHOULD I SUBSCRIBE?
Selling Puts & Calls is a unique value oriented trading community. You will receive initial training in little known, profitable trading strategy. You will then receive ongoing trade recommendations and evaluations. Finally, you will use a customizable personal trading journal to track the arc of your trading progress!
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