Quick Option Introduction
In the stock market world, the risk is the price of a stock or the price of a stock index. Option buyers usually own stocks that need to be insured against falling prices. In that case they can buy put options. Put options offer the right to sell stocks for a specified price no matter what the market price is.
Alternatively, buyers that are looking to buy stocks in the future can buy an option to insure themselves against rising prices. In that case they can buy call options. Call options offer the right to buy stocks for specified price no matter what the market price is.
To have this flexibility, the option buyer has to pay a fee -- the so-called premium to the seller of that option. This premium is not refundable no matter if the option is exercised or not.
As I am focusing on income and consistent profit, the strategies covered here are generally from the sell-side. That means I want to earn that premium.
The biggest advantage of selling options is the premium received. That money will always be collected no matter what the stock market does. So this kind of income is highly independent of any stock movement.
The second advantage is the freedom of choice what we do with that premium. We only need to hold enough cash to cover the options that we have sold.
As options are like insurance policies that will only be exercised if the the damage occurres there is a high chance that we can just keep on collecting income until -- once in a while -- the option buyer will ask us to cover his risk.
The disadvantage is the high risk involved. Usually that risk is manageable and can be reduced with hedging strategies. But like in any other business there is no guarantee of success.
The business of an option writer who sells options to his customers is to manage that risk accordingly. If he does his job right, he can still earn a huge profit.
Techniques and Strategies
As the field of option trading is almost unlimited I will explain the techniques involved in separate articles on this website. Briefly, there is one basic strategy that can always be found in any option trade: Option spreads. They are the hedges to reduce potentially unlimited risk to a size of loss that can always be managed.
Speaking of risk, the risk management for option traders is by far the most important part of the strategy. Option traders always need to know what they will do in which situation. That is what the option strategy will be describe in detail.
Further Readings About Option Strategies
I want to share some great articles about option basics and strategies. The topic is so wide that there are thousands of possibilities on how to trade options. That is the reason why I like that tool so much!