At any given time, an equities options trader can do one of two things: buy or sell. In this article, we will look at how the best way to sell stock options varies according to your situation.
Buy or Sell?
Options traders may either buy or sell contracts. There are several key differences between each action:
- Buy: When you buy a call or put option, you secure the right to buy or sell shares of stock at a specified price in the future. Profits are theoretically unlimited and are realized above (calls) or below (puts) the contract’s strike price. The trader’s only risk is the paid premium.
- Sell: When you sell or “write” a call or put option, you guarantee the viability of the contract. Gains are limited to the collected premium, and the assumed risk is unlimited.
For many traders, selling call and put options is a nonstarter because of the potentially unlimited risk exposure. However, other options players invest extensive resources in finding the best way to sell stock options. Read on to learn more about when selling calls and puts can be a lucrative trading strategy:
Flat Markets
Periods of low implied volatility provide the ideal conditions for options traders to sell calls and puts. Implied volatility is the expectation for future price action. In stock options, a contract’s implied volatility is called its “implied vol.”
Contracts with low implied volatility typically command a lower premium because the chance of the contract finishing in-the-money (ITM) above (call) or below (put) strike is minimized.
Assuming low implied volatility, out-of-the-money (OTM) stock options are prime candidates to be written. Traders often view writing OTM options with low implied volatilities as the best way to sell stock options and generate cash flows from collected premiums.
Bullish or Bearish Bias
Aside from flat markets, options traders may also write contracts when a decisive bullish or bearish market bias develops. However, the mechanism by which selling stock options generates gains varies greatly depending on the bias.
Perhaps the most traditional means of making money in the stock market is to buy low and sell high. Options can help traders do just that while also enhancing the application of enhanced financial leverage.
Selling stock options to gain long-side market exposure is more involved than the “buy low, sell high” mantra. To secure bullish exposure, you write put options. If the price holds or rises above strike, the put contract expires worthless . This scenario locks in the premium for the option writer.
Any trades are educational examples only. They do not include commissions and fees.
If you hold a bullish bias toward shares or indices, writing ITM or OTM puts may be the best way to sell stock options.
In the stock market, it can be a challenge to secure short-side exposure to an individual stock or index product. Typically, a trader’s ability to actively short sell equities products is limited to minimal leverage or specialized instruments, such as geared inverse exchange-traded funds (ETFs).
Nonetheless, selling high and buying low is as effective as buying low and selling high. Options traders seek to cash in on a bearish bias by writing ITM or OTM call options. If the price holds or falls beneath strike at expiry, the writer collects the premium as the contract becomes worthless.
If you are bearish toward a stock or index, then writing ITM or OTM puts could be the best way to sell stock options and diversify your portfolio.
