1. Covered Call Writing:
In a covered call strategy, you’ll sell call options against a stock you own. This strategy benefits from higher implied volatility since higher volatility usually leads to higher option premiums.
Steps:
- Select a fundamentally strong stock that you’re comfortable holding for the long term.
- Monitor the stock’s price and implied volatility.
- When implied volatility is relatively high, consider selling covered calls.
- Choose a strike price for the call options that is slightly above the current stock price. This provides some potential upside profit while still generating income.
- Sell call options with an expiration date that aligns with your investment horizon.
2. Cash-Secured Put Writing:
Selling cash-secured puts involves selling put options while setting aside enough cash to cover the potential purchase of the underlying stock at the strike price. This strategy benefits from higher implied volatility as well.
Steps:
- Identify a stock you would be comfortable owning if the price were to drop.
- Monitor the stock’s price and implied volatility.
- When implied volatility is relatively high, consider selling cash-secured puts.
- Choose a strike price for the put options that is slightly below the current stock price and reflects a level at which you’d be comfortable owning the stock.
- Sell put options with an expiration date that aligns with your investment horizon.
Considerations:
- Be prepared to purchase the underlying stock if the put options are exercised. This is why it’s important to choose a stock you believe in fundamentally.
- Diversify your strategy by choosing different stocks across various industries.
- Stay updated on the market and the stocks you’re involved with. Adjust your strategy based on changing market conditions.
Risk Management:
- Only sell options on stocks you’re comfortable owning at the given strike prices.
- Use proper position sizing to ensure you’re not overcommitting to any single trade.
- Set stop-loss orders or buy-back options if the underlying stock’s price moves significantly against your position.
Conclusion:
This strategy involves selling covered calls and cash-secured puts to generate income while factoring in implied volatility. Remember that options trading carries risks, including the potential for significant losses, and it’s important to have a solid understanding of the strategy, the underlying stocks, and the market conditions before implementing this approach. Consider seeking advice from a financial advisor or professional options trader before proceeding.