The benefits of writing an option
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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.
What are the benefits of writing an option?
The benefits of writing an option
The Strategic Advantage of Selling Options
Time as an Ally
When investors write options contracts—essentially selling options—they position time as a favorable factor. Purchasing options requires not only correctly predicting directional movement but also sufficient velocity for the stock to reach profitability before expiration expires. Each passing day without favorable movement erodes value. Conversely, selling options generates immediate cash while establishing high probability scenarios. Even when price movement contradicts expectations, the trade remains profitable provided the strike price remains untouched by expiration.
Practical Illustration
Consider this scenario: after thorough research, you determine that ABC stock, currently trading at $100, represents a compelling investment opportunity. Several approaches exist—direct share purchase, call option buying, or put option selling.
Purchasing the 60-day 105-strike call at $6.00 requires the stock to not only surpass $105 before profitability begins but also overcome the $6.00 premium paid. Effectively, ABC must reach $111 before realizing profit—a continuously uphill battle.
Alternatively, buying shares outright at $100 each becomes expensive rapidly, with losses commencing immediately upon any downward movement.
A third approach involves selling the 30-day 90-strike put for $4.00. Provided ABC remains above $90 during this period, the $4.00 converts to pure profit. Rising prices yield profit; sideways movement yields profit; even incorrect directional expectations with prices declining into the low 90s still generate profit.
Should ABC fall below $90, assignment requires purchasing shares at that price—yet you desired ABC ownership originally. Compared to purchasing at $100, this forces acquisition at a 10% discount from your initial entry point. Moreover, the $4.00 premium received upon trade initiation reduces your effective cost basis to $86, representing a 14% advantage over purchasing just thirty days earlier.
Cumulative Impact
This illustrates why premium selling constitutes such powerful methodology employed by sophisticated investors. Collecting modest premiums month after month may appear insignificant when examining individual trades. However, executing this approach consistently—accumulating multiple premiums while acquiring shares only at discounted levels—generates rapidly compounding profits.
What are the benefits of writing an option?
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: