Option Selling, Benefits and Risks

Option selling is one of the most powerful strategies to make money in the stock market.  It involves not having to decide where a stock will move in the short term, but where a stock will not move in the short term.

The major benefits are.        

1.       You have a much higher probability of being correct.

Your chances of being correct are greatly increased because you only have to determine where a stock will not go.   For example, you find a stock that is trading at $40 and you believe it will go higher.  Well you can buy the stock and make money if it goes higher or you could sell a put on the stock at say $35.

Now you can profit as long as the stock stays above $35.  So even if the stock falls a little you can still be profitable.

2.       Higher confidence.

Because it allows you to be right more often it also gives you higher confidence.  That is important to have when trading the markets.

Even though option selling can be very profitable and come with high probabilities there is also risk.  If you look at the above example, the above example we could possibly lose up to $35 on this trade.  If the stock goes to $0 we would be forced to buy it at $35 and sell it at $0.

It is for that reason that I always want to manage my risk when I sell options.  One effective way to do this is by not only selling a put but by buying a lower put as well.

So if we sold the $35 put and made say $2 then turned around and bought the $30 put for $1, our risk would have just been limited to the difference between $35 and $30 or $5. 

That is not the only way to limit your risk, but it is a good one.

For more information about selling options visit http://www.stocks-simplified.com/option_selling.html

For more on credit spreads visit http://www.stocks-simplified.com/Option_Spreads.html