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Option Selling 101 : Discover the Best Strategies to Increase Your Profitability

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Published Date: 12 Nov 2024Updated Date: 12 Nov 20246 mins readBy MOFSL

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Introduction:

Option trading offers the potential to earn uncapped profits, but it requires a thorough understanding of the strategies, market behavior, and risks involved. One such trading strategy is selling options. In this strategy, traders receive a quick income in the form of premiums associated with the sale of options.

To sell options, traders write or issue an option contract granting the buyer the right to either sell or purchase an underlying asset at a predetermined strike price before or on the expiry date. While selling a call option, the underlying asset of the options contract must be sold at the agreed-upon strike price when the buyer exercises their option. On the other hand, by selling a put option, you are obligated to purchase the underlying asset at the predetermined strike price.

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In this article, you will be introduced to the benefits of options trading and top option selling strategies. Read on to know more.

Benefits of Selling Options

Here are some benefits of selling options:

The cost involved for holding stocks can be reduced by selling options. For example, if there’s no movement in the stock price, selling a call option at a higher strike price brings in a premium.
When compared to buying options, where a premium is paid, selling options offer instant cash flow. This gives traders a chance to better manage their capital due to the limited upfront capital needs.
While selling options, traders can calculate the maximum potential loss which can be incurred. This makes it easier to make informed investment decisions.

Best Strategies for Option Selling

Here are some of the best strategies for selling options for investors with varying levels of experience and market outlook.

Selling Strategies for Bearish Options

The following strategies are employed in a bearish market to sell options because you believe the underlying asset's value will reduce. By selling the call options right away, you profit from the expected decline in the price.

Put Spread

You must purchase an in-the-money put option while selling an out-of-the-money put option. This spread is profitable when you believe the market is bearish and the price of an option will reduce upon expiry.

Bear Call Spread

If you believe the value of a stock will be reduced, execute this strategy by purchasing and selling one out-of-the-money and in-the-money call option for each. The profit earned is the difference between the amount earned from selling a call option at a lower strike price and purchasing a call option with a higher strike price.

Selling Strategies for Bullish Options

If you believe the underlying asset's value will increase, you can use the following option selling strategies. By selling such options, you will profit through a premium generated from the expected price rise.

Covered Call

A call option must be sold against the underlying asset while holding it to execute this strategy. If the value of the underlying stock rises and is more than the strike price, you earn a profit.

Bull Put Spread

You must sell and purchase a put option with varying strike prices. The strike price of the put option purchased must be lower than the put option sold. The profit earned will be equivalent to the net credit received while restricting the possible loss that can be incurred.

Cash-Secured Put

Sell a put option and deposit the same amount in the margin account. Because you can buy the stock at the strike price even if its value is below the threshold, the put option premium is the profit.

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Selling Strategies for Neutral Options

The following strategies can be used when the market conditions are neither bearish nor bullish and are neutral.

Short Straddle

To execute this strategy, you must sell one call and put option, each with the same strike price. Profit is earned in the form of a premium received upon the sale of the call and option options, provided the stock price stays within a predicted range.

Short Strangle

In this strategy, you must sell a call option with a higher strike price than the put option. Profit is the premium earned from the sale if the stock price is within the predicted range of strike prices.

Intraday Options Trading Strategies

Intraday options trading aims to profit from short-term price fluctuations within a day by employing trading techniques. Here are the strategies employed for intraday options trading:

Momentum: This strategy requires traders to monitor news and events that affect target stocks. Prices will likely rise and fall as trends persist.
Breakout: It focusses on timing transactions around significant price fluctuations in securities. Profitable trades happen when securities break out and continue to move in the same direction.
Reversal: A high-risk strategy that goes against market trends, based on calculations and extensive industry knowledge
Scalping: This strategy benefits from little price fluctuations and is suitable for both liquid and volatile shares.
Moving average crossover: The trades in this strategy are based on uptrends (buy) and downtrends (sell) as prices cross average levels.
Gap and go: The trades are based on gaps between the previous day’s close and the current opening price.

Conclusion

Options trading offers investors a versatile and profitable investment avenue. Regardless of your risk tolerance and investment objectives, you can find an options trading strategy to fit your portfolio. As with any other form of investment, understanding trading strategies, market conditions, and risk levels is required to make sound investment decisions. It is also important to understand technical jargon to make informed decisions when trading.