While there are numerous options strategies available to all kinds of traders and investors, we are going to target ones we feel can create a good income stream. They are Covered Calls, Short Puts, and Put Ratio Spreads. Before discussing these strategies, here is a quick explanation of Options.
There are 2 types of options; Calls and Puts. They have the same internal characteristics with the exception of expectations. If you buy a Call, then you are expecting the stock price to go up and if you buy a Put, then you are expecting the stock price to go down. Here are the common traits of Calls and Puts:
- One option controls 100 shares of stock. Therefore, if you own one Call, you have the option to purchase 100 shares of stock.
- The price shown in your brokerage account needs to be multiplied by 100 to determine the actual cost of the option.
- Options have an expiration date. This is the date the option is no longer valid. There are weekly option dates, monthly option dates, quarterly option dates, and long-term options called LEAPS.
- Options have a strike price. This is the price you are permitted to buy (Call) or sell (Put) the stock.
For instance, if you purchased one January 21, 2022 $20 Call of a certain stock, that mean you have until January 21, 2022 to purchase 100 shares of that stock for $20 each.
We won’t be buying any options unless we are also selling options as we cannot get an income stream by buying them.
Margin Account
Mostly, in order to obtain an income stream with options, the strategies require selling options instead of buying options. In order to get the best return, an individual account should have Margin or better yet, Portfolio Margin activated. Unfortunately, IRA accounts must be cash secured as Margin is not available in these types of accounts. These strategies are still possible in these accounts but sometimes, it will tie up more cash than necessary.
Income from Options
There are 3 different strategies that we use to create income. These may not be done month after month as they are very dependent upon specific circumstances. But they are worth exploring.
- Covered Call – The easiest to understand is the Covered Call. This process includes purchasing a stock and then selling one out-of-the-money Call for every 100 shares purchased. This process works best with higher dividend paying stocks such as AT&T, Verizon, etc. The combination of the dividend plus the Put, can create a nice income stream. The strategy is to “roll” the Puts every month to keep the income going.
- Short Put – This strategy is to sell an out-of-the-money Put that is below the current price of the stock. Typically, the strike price would be below some type of support line.
- Put Ratio Spread – This is a ratio of selling 2 puts and buying 1 Put. The risk, reward, and price move expectations are based on the strike prices selected in the options. Overall it performs better when the price drops but it can be structured to also produce a gain if the price rises.