Option selling – Investing – Trading

There are three main, but very different approaches to the financial markets: Investing, trading and option selling.

Investing in stocks:

When I first started to be active in the financial markets, I started with buying shares. This is relatively simple and straight-forward strategy. My aim was to buy undervalued stocks and hold it for several years or even decades. In best case scenario, one would achieve a profit in terms of dividends as well as increase of the stock’s price. My focus laid entirely on fundamental analysis. I followed the earning figures presented by the company, its debt, future outlooks, company’s management etc.

Good approach, if you have starting capital

Investing in stocks is a good strategy if you already have a sufficient Suitcase full of dollarsamount of money. The disadvantage here is that this method does not provide you with a monthly salary. European stocks usually pay dividends only once per year. The situation is better in the American markets, where the dividends come, as a rule, four times per year. Still, if you do not have hundreds-of-thousands of dollars on your account, it might be difficult to rely only on this source of income.

Let’s have a look at a very concrete example: On a 10.000$ investment in shares, paying 3% dividends p.a., you will get yearly 300$ minus taxes. Your investment might increase while the stock price rises, but that is only gain in the book. As you can see, there is no cash flow which you can use to cover your living expenses. Therefore, we have to look for an additional income on the financial markets.

Trading:

There is a huge amount of different underlying which you can trade, beginning with stocks, through bonds, futures or currencies. Some people also trade a number of synthetic instruments and a few of these might indeed offer some advantages. However, one important note to mention: This blog will not pay any attention to instruments where our counterpart would be a bank, for example knock-out certificates or similar. My only advise: Please stay away from these products.

For a beginner, the most easiest way is to focus on shares. Traders are interested in charts, not in the fundamental data of a company. The reason is that traders usually hold their position a very short time (few days, hours or even minutes). Therefore, the fundamental data do not have much impact on them. Instead, they read charts with the hope to predict where the price will go.

Trading is a tough job in the financial markets

Predicting future might be a little bit tricky. No wonder, the majority of traders lose their money.

Despite this fact, I share the opinion that the technical analyses used by traders is useful. There are many indicators, which one can use to get more information about the market. One of the most basic ones is to determine where the support or resistance are. Or better to say, where the demand and supply zones are located for a particular stock. There, the big money is waiting to sell or buy.

If I were a complete novice with no experience in financial markets, I would not start with a directional trading. Only in the case that I would be thinking as follows. “OK, I know that I am going to lose money, but I am ready to do it in exchange for the valuable experience from the actual practice.” Needless to mention, and this applies to every beginning, I would risk as little money as possible.

The knowledge from trading is useful and can be applied in other areas, for example when selling options. This is the last and most important point I am going to introduce.

Option selling:

My way to achieve independence

This is the way how to generate monthly income in the financial markets. Yes, by option selling. An option is something like an insurance. You can sell an “insurance” to the option buyer that you are ready to take the risk resulting from his or her investment position.

For the option buyer, an option is the right to either sell or buy an underlying (shares, futures…) for a specified price.

Examples are always good for illustration: Your neighbor owns 100 shares of Tesla which he bought for 300$ each. In order to better sleep at night, he buys a put option. This gives him the right to sell 100 shares of Tesla for 260$ each with the expiration date, for example in 45 days. Whatever happens, even if the price sinks to 0$, he will be able to sell the shares for 260$ to the option seller. For this right, he pays a premium – the price of the option – to the option seller. The best thing in option selling: Every option is valid just a limited amount of time until it expires worthless. The longer the option is valid, the more expensive it is.

Premium-flow - Option selling

Option selling offers many advantages – let time work for you

Here comes the option seller who is you or me. When selling options, we are selling time and time is our best friend. Using the above-mentioned example, we have the obligation to buy the Tesla shares for 260$, when the option buyer decides so. As long as the price does not run extremely against us, we are fine.

Actually, there are three scenarios when we will make money with option selling. When the price of the underlying asset goes sideways, when it goes up or even if the price slightly decreases (not too much, not too fast). On top of that, time works for us every day, even on weekends when the market is closed. There is a smaller and smaller chance that the option will end up in the money.

To be objective, it is only fair to mention that things can go wrong. We, as option sellers, will come under pressure when the price jumps extremely against us in a very short period of time. Option selling, in a weak hand, might be a risky business. The reason is that we can lose much more than what was the plan at the beginning. However, there are ways how to limit the risk and repair even the losing positions. As you become familiar with option selling, you will soon realize that it is much safer instrument than pure speculation through a simple directional trading. The probability to win is on our side and that is an important edge.