Options trading may be a way to potentially generate income for the experienced trader. The strategies outlined in this article are used to generate income or to buy stock at a discount. These strategies come with advantages and risks that are outlined below.
Before we jump into what they are and how they are used, here are a few terms to keep in mind:
Covered calls: an options trading strategy involving an investor holding a bought (or long) position in an underlying asset, such as a stock, while simultaneously selling call options on the same asset.
Writing/ Writer: this has the same meaning as selling/seller of an option.
Covered Call
A covered call involves selling a call option while owning the underlying stock. The strategy aims to generate additional income from premiums received from selling call options. This strategy is used when traders think that a stock price is unlikely to rise much further and not above the strike price with the primary objective being increased income from existing ownership of shares.
• Ideal scenario: Use this when you’re moderately bullish or neutral on the stock, i.e. you expect the stock to remain below the strike price before or at expiry.
• Benefit: Generates income from the premium received for selling the call while retaining the stock if the stock price is below the strike price at expiry.
• Risk: Limits upside potential if the stock’s price surges, as the stock owned will be called away at the strike price at the discretion of the call buyer who will exercise their right to buy is the stock has risen above the strike price. This strategy also does not protect against significant stock price declines.
Example of a covered call strategy
The Setup:
• You own 100 shares of Newmont Mining (NEM) stock, currently trading at $46.50 per share. • You believe NEM will stay below $55 in the near term and if it rises above $55 you are happy to have your stock called away. • To generate income, you sell 1 call option with a strike price of $55 (representing 100 shares) for a premium of $2 per share.
Source: Tiger Trade, prices as of 25th February 2025
Option details: • Strike price: $55 (the price at which the buyer of the call option can purchase your shares).
• Option premium: $2 per share = $200 total (100 shares × $2). • Expiration date: Let’s assume three month’s from now.
Possible outcomes:
Outcome 1: The stock is below $55 at expiration, assuming it's equal to $53. The option expires worthless because the buyer will not exercise the right to buy at $55 when the stock is trading below that. You keep the $200 premium as income, and your profit will be:
• Value of option: $0, because the stock price at expiration is less than the strike price.
• Profit from holding the stock: $300, which is equal to (53-50)*100
• Premium received: $200
So the total net profit is: $500
Outcome 2: The stock rises above $55 at expiration, for instance, it reaches $58
Your net profit will be:
• Value of option: -$300, (55-58)*100. The option will be exercised, and you must sell your shares at $55 when the share is valued at $58
• Profit from holding the stock: $800, which is equal to (58-50)*100
• Premium received: $200
So the total net profit is: $700. This is also the maximum profit you could possibly gain from this covered call transaction.
Outcome 3: The stock drops significantly and your shares lose value, but the $200 premium partially offsets some of the losses.
For instance, if NEM falls to $45, you lose $500 in stock value, but your net loss is $300 after accounting for the $200 premium.
Break-even point: Your break-even price is the stock price minus the premium: $50 - 2 = $48 per share.
It's important to note that in the examples outlined, brokerage and other trading fees have not been taken into account.
By using the covered call strategy, the aim is that the premium received from the sale of the call effectively reduces the cost of buying the shares. Traders generally find that holding shares and selling call options has less volatility than holding a share portfolio alone. The outcome every month means that potentially, results will be less extreme than they would be with normal share ownership.
Cash-Secured Put
A cash-secured put involves selling a put option while setting aside cash to potentially buy the stock if it is assigned. The aim is to be allocated and to acquire an underlying asset that is below today's market price. The investor is bullish on the underlying asset and hopes that the market price drops below the strike price temporarily allowing the seller to be assigned the put (obligation to buy at the strike price). If the strategy goes as planned, the investor will be able to buy the underlying asset at a price below the market value if it has been sold as an out-of-the-money put.
• Ideal scenario: Use this if you want to acquire the stock at a lower price.
• Benefit: Collect the premium, reducing the effective purchase cost.
• Risk: Must buy the stock at the strike price if assigned, even if it falls further. The risk is the stock does not fall and you don't have any shares if and when the stock rallies.
Example:
Here’s an example of the strategy:
Scenario
• Stock: First Financial Corporation (THFF)
• Current stock price: $50 per share • Put strike price: $45
• Option premium: $2 per share • Contract size: 100 shares • Cash required: $4,500 (strike price × 100 shares)
Source: Tiger trade app, 5th February 2025
Steps in the strategy
Sell the put option:
• You sell one put option contract for THFF. with a strike price of $45 and an expiration in 30 days. • You receive a premium of $2 per share, totalling $200 (100 shares × $2).
Set Aside Cash:
• Since the strike price is $45, you set aside $4,500 in your account to cover the cost of buying 100 shares if the put option is exercised by the buyer and assigned to you.
Possible outcomes at expiration
If the stock price is above $45: • The put option expires worthless, and you keep the $200 premium as profit.
• No stock is purchased, and the cash remains in your account.
• Return on cash secured:
Return =premium received/cash secured =200/ 4500 = approx 4.44%
If the stock price is below $45: • The put option is exercised by the buyer and assigned to you, and you are obligated to buy 100 shares at $45.
• Your effective cost basis for the shares is:
Cost basis = strike price - premium received = 45 - 2= 43 per share.
• You now own 100 shares of THFF at an effective price of $43, which is lower than the initial market price of $50.
Options trading calculator
While options strategies can be confusing and calculations may not be your forte, Tiger Trade offers tools and educational resources to help investors navigate and explore what opportunities options trading may provide. Tiger Trade offers an options calculator on its app to help investors calculate the theoretical price of an option for a given implied volatility and at a specific future time when the stock price is at a certain level. To use this feature log in to Tiger Trade > Quotes > Select Option you want > Option chain > Select the expiry date > find the specific call/put click> scroll down to locate the options calculator.
From here:
Enter the current price of the underlying asset (stock price).
Enter the strike price of the option.
Set the expiration date of the option.
Input the predetermined implied volatility.
Source: Tiger Trade app
All strategies involve risks and by understanding risks along with the benefits associated with each strategy, investors will be more aware of their risk appetite when investing. Learning options trading and speaking to a financial adviser is recommended before undertaking any investment in options trading. To practice your options trading, Tiger Trade offers a free demo account where users can explore strategies and opportunities without risk to real capital. Once you are comfortable with your strategies and want to look into diversifying your portfolio, you can trade with 4 x zero monthly brokerage for options, US or ASX stocks or ETFs*.
*New clients & unfunded existing clients only. Only min. brokerage waived for 4 ASX, US stocks or options trades. Third-party fees and other fees still apply. See T&Cs for details
Capital at risk. Options trading carries a high level of risk and may not be suitable for all investors. You should only trade with money you can afford to lose. See FSG, PDS, TMD and T&Cs via our website before trading. Information provided may contain general advice without taking into account your objectives, financial situations or needs. Past performance is no guarantee of future results. Graphics and charts are for illustrative purposes only. Tiger Brokers (AU) Pty Limited. ABN 12 007 268 386 AFSL 300767
