Covered Option Trading to Protect the Trader
Selling options has problems— margin requirements, poor returns, and expiration issues—yet this can still be an effective way to generate income and increase returns when done correctly. All of the problems are tied to selling options by themselves, or “naked.” When an option is sold naked there is no counter side to limit the “unlimited” risk that it has. The secret, like every other risk management strategy, is to couple the selling of an option with another strategy designed, intentionally or unintentionally, to protect the trader from any erratic moves. This is known as “covered option” trading.
Without question, selling options can have a positive effect on a trader’s account. It is a simple income-producing trading strategy that can power-boost any trader’s returns. To make it a successful enterprise, a trader is required to do two things—control his profit expectations and increase the vigilance over his trading. Then it becomes a simple endeavor to implement the strategies.
Traditionally a “covered option ” is the combination of an option and a futures or cash position. The option is sold against the futures or cash position to generate income. Yet there are many different ways to “cover” an option. Options can be staggered with multiple strike prices or they can be tied to other risk management strategies such as Collars or Synthetic Options. However selling covered options is approached, it diminishes if not eliminates many of the problems that selling naked options can have.
