Summary
- Option selling is a professional technique for adding income and mitigating risk by selling options to speculators and those who need insurance on long positions.
- The rules for selling options are very aligned with our rules for buying and selling stocks.
- Look to sell COVERED CALLS when stocks or ETFs are approaching or already OVERBOUGHT on the WEEKLY chart using RSI.
- Look to sell CASH SECURED PUTS when stocks or ETFs are approaching or already OVERSOLD on the WEEKLY chart using RSI.
Retirement Income Options analysis and investing ideas are designed to help retirees and near retirees with six and seven figure portfolios generate higher income and mitigate risk while still participating in equity gains.
Our Retirement Income Options strategy makes extensive use of covered call selling and cash-secured put selling. Our experience is that by using our techniques, you can add from 4% to 12% per year to your bottom line while slightly lowering your equity risk.
Option Education Links
Cash-Secured Put Basics
Covered Call Basics
Option Selling Is A Professional Move For Smart DIY Amateurs
Option selling is a professional technique for adding income and mitigating risk by selling options to speculators and those who need insurance on long positions. These are not speculative trades. Option selling by its nature is designed to coincide with a “buy low, sell high” mentality.
There are only 4 option trades that are at the core of EVERY option strategy. Here is a very easy chart to remember for options trading.
Our option selling strategy takes this cycle into account:
As you learn how to handle options within your portfolio, you can come back to that image over and over again. Selling options is not “one shot” deal. It is a process that takes into account buying a stock (or ETF), selling an option and selling a stock (or ETF).
Take the time to read the linked documents and watch my Retirement Income Options webinar archives.
Option Selling Quick Thoughts
In general, we like to sell cash-secured puts for building positions in favored stocks while generating income and managing risk.
There are opportunities for covered calls, usually paired with trimming an appreciated position that has become overbought and/or overvalued. Generally, trim an overbought position and sell a covered call against a portion of the remainder, leaving some uncovered (often starter position size) in case it continues to run, i.e. we like to ride our winners.
How I Trade Cash-Secured Puts
First off, I never use margin. You should NEVER us margin. If you use margin, you can lose a lot of money. If you use margin and lose a lot of money, you will not get any empathy here. It’s called a “cash secured” put for a reason, it’s secured with your cash, not margin credit.
After I have a starter position, I will often sell a cash-secured put to add to the position at a lower net cost in the near future.
There are a few reasons to sell cash-secured puts when building a position:
- you reduce your risk of buying to fast and too high, which many people do, akin to a Martingale gambling system of doubling down.
- you receive income for selling the put.
- you are essentially setting a limit price that you are willing to buy at in the next few months which limits mistakes.
Notice the first and third things are similar. It’s all about managing risk.
You must use technical signals when trading options. I have not seen any other way in 25 years that works well. The simplest technical signal to use in selling puts is to use the weekly Relative Strength Index chart.
When RSI on the weekly (not daily) chart is in the 30s, that is generally a good time to look at selling a put.
Conversely, when RSI on the weekly chart is in the upper 60s or 70s, that is generally a good time to look at selling a covered call on a portion of your holdings. More below.
Here is a primer on technical basics you must know:
Technical Trading Basics: & Buy Zones
Cash-Secured Put Selling Checklist
- You want to own the stock at the strike price, which is a function of short-term valuation and projecting future value.
- The stock is oversold or approaching oversold on the weekly RSI.
- You have considered the potential impact of upcoming earnings announcements, business developments and dividends.
How I Trade Covered Calls
I sell covered calls in two different situations:
- When a stock I own has appreciated and I would like to sell some or all at a slightly higher net price.
- When a stock I own has started to show technical weakness, but I want to own it for the long-term.
Covered Call Scenario 1 – appreciated stock or ETF that is approaching or already overbought on weekly RSI:
You write a covered call after a stock or ETF gets into the middle of the overbought vs oversold range, or wait until it approaches or gets into overbought. Again, using weekly charts on RSI.
In this situation, I will generally trim, i.e. sell, some of the position, somewhere between 1/6 and 2/3 of a position and sell a covered call on much of what is remaining. If I think the stock or ETF, but generally a stock, can break out to much higher levels, then I will leave a portion of the position uncovered so I can take part in future gains. Here is an example:
Covered Call Scenario 2 – stock is weakening, but I want to hold it long-term, for example, because I expect it to rise in price eventually and it pays me a dividend while I wait:
In this scenario, usually with slower growing dividend paying stocks, I want to add income to mitigate my risk a bit. Because the stock is stalling out or even falling a bit short-term, I sell a covered call a little out of the money.
To be sure, if I think the stock is headed for a bigger loss, anything exceeding about 12% is where I get worried, I am more likely to sell. The dividend is what might keep me in the stock though, particularly REITs, utilities and other companies with low risk of bankruptcy. Here’s an example:
The Buy/Write Covered Call:
The scenario I do not use often, almost never in fact, is the buy-write. A buy-write is when you buy a stock and immediately sell a covered call.
Covered Call (Buy/Write) by Options Industry Council
The reason I do not like this strategy is that if you are even a little better than average stock and ETF picker, then you want your investments a chance to appreciate. Your risk tolerance will determine when you sell a covered call, either when it is in the middle of the overbought/oversold range or overbought, as described above.
If you want to do buy/writes, then simply sell a covered call after you buy a stock or ETF when it is put to you. You are dramatically limiting your upside in my opinion, but it is a way to collect premium more regularly and can cut risk a bit.
Covered Call Checklist
- You want to trim the holding at the set strike price because that price is overvalued versus your assessment of the stock’s value in the next year or two. This is tricky to do.
- If the stock is overvalued relative to longer term projections of value, then you should just be selling stock.
- The stock is overbought or approaching overbought on the weekly RSI, MFI and/or Chaikin Money Flow.
- You have considered the potential impact of upcoming earnings announcements, business developments and dividends.
Final Option Selling Thought
If you always think about the stock or ETF fundamentals first and then overlay technicals you will almost always be alright in the intermediate and long-term.
To be sure, sometimes in the short run the unexpected, unexplained or unforeseen happen. We can’t avoid that 100% of the time.
If we focus on quality and the signals the market is giving us, then we can almost always avoid permanent losses. That, easier said than done, approach is the backbone of a winning portfolio (that and a few big winners).
