How To Read Option Chains

When most buy and hold investors think of investing strategies, the last thing that probably comes to mind is stock options. That’s because the typical risk tolerance of the buy and hold investor is lower than that of an active options trader. How To Read Option Chains

Also, there is no shortage of information relating to the risks associated with stock options, so the average long investor is very likely to shy away from stock options altogether.

Insofar as that tendency relates to buying call or put options, the decision to stay out of the options game makes sense for the conservative investor. However, it might be a very big mistake to ignore the other side of the options arena: writing options.

When you hear the term, “writing” options, it refers to being on the selling side of an equity options contract as opposed to the buying side.

Selling stock options and writing stock options mean the same thing.

Selling Stock Options: The Covered Call Strategy

Selling options against shares you own is called writing a “covered’ call. Covered calls are sold by investors that own shares of a particular stock who are interested in collecting the “premium” (money) that writing options will add to their portfolio.

For example, a buy and hold investor who owns 300 shares of ABC company worth $50 per share might decide he’d like to collect a nice “dividend” on those shares by writing options against them. How To Read Option Chains

If our example investor checks the options chain, he might see that call options with a $50 strike price, expiring 30 days in the future, are currently selling for $4.00 per share.

He may decide that he really doesn’t want to sell his shares for $50, but would gladly settle for $55, so another look at the options chain shows him the $55 calls are going for $1.75 (or $175).

By selling stock options at the $55 strike price for all of his 300 shares, he is selling someone the right, but not the obligation, to buy his ABC company shares at $55 anytime between inception and expiration of the options.

In this case, since our investor owns 300 shares, he can sell three contracts at a value of $175 per contract. Once he engages in writing options against his shares, $525 (less broker fees) hits his account and the money is his to keep regardless of whether or not the ABC shares have to ultimately be sold to a buyer.

And better yet, if the shares remain in the investor’s portfolio after the covered call options expire, that investor is free to write new call option contracts valid until the next expiration date, thus capturing another healthy premium to add to his gains.

For conservative buy and hold investors, writing options against shares they own provides an excellent opportunity to realize gains without necessarily having to sell the stock shares themselves. For the aggressive investor, writing options can be a very lucrative opportunity if you manage the risk properly.

Take the time to learn how to use stock options and it will be one of the best financial decisions you’ve ever made. How To Read Option Chains