Houghton and Atkeson

3 Ways to Kick-start Your Options Trading Returns

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There are many reasons to trade options -- namely, to spend a little bit of money for the possibility to make BIG returns -- but we can boil them down to three main objectives:

• Hedging
• Collecting premium
• Betting on a stock, sector or market's direction

THE HEDGE EDGE

The vast majority of options trades are executed for the purpose of hedging -- that is, protecting the value of what you already own. Investors generally buy and hold stock, or what's known as "being long" stock, and one of the most-straightforward ways to protect the value of the stocks in an existing portfolio is to buy a put option.

If your stock declines in value, the put premium should rise and help limit any losses you may incur in the event of a pullback in the share price. If the stock appreciates, however, the option's loss in value is limited to the cost of the put.

The same is true for short-sellers (i.e., someone who borrows their broker's money to short stocks or options) who buy call options to cap their potentially unlimited loss in case their short trade goes against them.

A 'PREMIUM BLEND' OF INVESTING STRATEGIES

Collecting premium, or selling volatility, is another reason why people trade options. The more movement that's taking place in the markets and in individual stocks, the higher option premiums tend to go. And during less-volatile times, investors who want to enhance the value of stocks held long can sell covered calls.

A "covered call," which is also called "writing" covered calls, means "selling to open" a call -- using your long stock as a hedge -- to generate income while the stock value is remaining fairly steady. Although the stock may not be making great advances, you are simulating gains by creating them yourself through the short sale (and, therefore, premium collection) of a call option.

In this case, an investor sells calls at a higher strike price than the current value of the underlying stock. For example, if you hold shares of Apple (AAPL) at $150, to benefit from this strategy, you would sell AAPL calls with strike prices of $155 or above.