Trading options get a bad reputation from horror stories of people losing it all in a casino-like fashion. But options trading can actually be quite safe.
As you amass a huge portfolio of dividend stocks, you may get the urge to generate some more income. Likewise, you may look to buy dividend stocks at rock-bottom prices to obtain maximum yields. I have two great (and safe) strategies for you.
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What is options trading? Options are derivatives of stocks and ETFs. That means you are trading paper assets derived from the underlying stocks.
I highly recommend you read a few books on options before jumping into the fire. I have read “The Options Playbook,” “Covered Calls for Beginners,” and “Credit Spread Options for Beginners.”
The first rule of safe options trading is that you want to sell options, not buy them. As the seller, you are giving insurance to someone else.
You can sell a call option that gives someone the option to buy your stock at a higher price in the future. You can sell a put option that provides someone the option to sell you their stock at a lower price in the future.
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Understanding options is only possible once you comprehend why someone would buy an option from you.
Why would someone buy a call option? Someone will buy a call option from you if they believe the price of a stock will shoot up very high.
For example, AT&T (T) is currently $15. They buy a call option at the strike price of $17 but believe it will move to $20. If this happens, they make $3 per share minus the premium they paid you.
Why would someone buy a put option? Someone will buy a put option from you if they believe their stock price may be falling.
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They stand to make a lot of profit when AT&T (T) is above $13 per share. Currently, AT&T is at $15, so they purchase a put option in case the price drop below $13. They are buying insurance from you to ensure they lock in their profits.
Tier 1 options strategies. I stick to the simplest and most basic options strategies out there. Your brokerage will have different Tiers of options trading, requiring you to demonstrate knowledge or resources to climb the chain.
The two Tier 1 options strategies I recommend are selling covered calls and selling cash-secured puts.
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Selling covered calls. Selling a covered call is when you own 100 shares of the underlying stock and sell them at a higher price in the future.
Let’s say you own 100 shares of AT&T (T), and the current price is $15. You can sell one call (each option contract is for 100 shares) for the strike price of, say, $17. You get a $3 premium for selling this call.
You get to keep the premium no matter what happens. If the price of AT&T doesn’t reach $17, you keep the shares and the premium. If it surpasses $17, and the buyer exercises their option to buy, you sell the shares at a profit and keep the premium.
Selling cash-secured puts. Selling a cash-secured put is when you don’t own the shares but have cash in place.
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When you sell a cash-secured put, your brokerage will lock in your cash for the duration of the contract.
Remember, selling a cash-secured put gives someone else the right to sell you their stocks at a lower price in the future. Let’s look at our AT&T stock again.
Let’s say the current price of AT&T (T) stock is $15. We sell a cash-secured put for a $13 strike price. Our brokerage locks up $1,300 ($13 x 100), and we collect a $3 premium.
We keep the premium if AT&T’s stock price doesn’t fall to $13. If it falls under $13, and the buyer exercises their right to sell, we obtain the shares and keep the premium.
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The book “Make Your Family Rich” recommends selling cash-secured puts on stocks that have dropped 10% over the last few days. This means if you get assigned the shares, you get rock-bottom prices and sky-high yields.
The back-and-forth game. If you didn’t see the flow between the two strategies, I will explain. Let’s say you start with a brokerage account with $1,500 and no shares.
You can start selling cash-secured puts against AT&T (T) shares. You can keep collecting the premiums until you get assigned shares.
Once you get shares into your account, you can sell covered calls while collecting the premiums. Eventually, someone will take your shares, and you’ll receive cash. Then you begin selling cash-secured puts again.
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You can play this game forever, ensuring you are buying low and selling high each time. The numbers don’t look high, but you can make a great amount of side income when talking about ten options contracts at a time (or more).
Using an options strategy with your dividend portfolio. I recommend creating a separate dividend portfolio for options trading.
Your dividend portfolio will become your good friend over time, and you don’t want to get shares assigned away.
I traded covered call options against my AT&T shares, and my shares got assigned away. I made some good money and bought the Preferred Share ETF (PFFA) shares with the proceeds.
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But losing my AT&T was not fun. I had those shares from the beginning of my dividend investing career.
My new options strategy. Once I retire (in 30 days), I will open a new brokerage account at a new firm. I don’t know where yet.
I may move all my stocks away from Charles Schwab and use that as my options trading platform. I used Charles Schwab to trade options, and I enjoyed the experience.
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Either way, I will start with $2,000 and sell cash-secured puts. I will keep doing the back and forth between selling covered calls and cash-secured puts.
I can use the premiums to buy different stocks or ETFs slowly. Or I can use the cash flow to put into an emergency fund or go on vacation.
The idea is to have an account that safely generates revenue from selling options contracts. I am excited to see how this unfolds.
Conclusion. I just learned that some brokerages pay interest on the money they lock up for your cash-secured puts. So trading puts is getting even better.
There are many reasons to add options trading to your dividend investing experience. However, safety should be of top concern.
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You can trade calls and puts without security (cash or underlying stocks). However, you can get into big trouble, especially if your stock suddenly moves up or down.
Finding safe ways to generate passive income takes a lot of work. Dividend investing and options trading carries some initial cash outlay to get into the game.
However, by taking your time, not getting greedy, and sticking to your ruleset, you can generate another 4-8% on top of your dividend yield.
Don’t gamble with options trading; take the slow and easy way. There is less yield, but you’ll slowly build a steady stream of passive income and have fun. Good Luck!
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Disclosure: I am not a financial advisor or money manager, and any knowledge is given as guidance and not direct actionable investment advice. I am an Amazon Affiliate. Please research any investment vehicles that are being considered. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article. All Right Reserved Military Family Investing
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