If you are just starting your options trading training, you may not yet understand where these ‘options’ come from. If I buy a call option, I am agreeing with another party that I can choose to buy the corresponding shares from that party, at the agreed price, at any time up to the expiry date of the option. But, as in any deal, there are two sides to this trade.

If I can buy the option from the other party, then he is selling the option to me. He can do this because he actually owns the corresponding shares, so he can supply the shares to me if I choose to exercise my option in the future.

Why would he do this? Well, if I am buying the option because I have an expectation that the price is going to rise above the agreed option price (the ’strike price’), then you can see that his expectation must be the opposite – that the actual price will remain below the strike price, in which case I am not going to exercise my right to buy at the strike price.

So what? So, I paid him for the right to buy at the strike price – if I don’t exercise my right to buy, then he simply pockets the price I paid for the option, and it is pure profit to him.

It’s a gamble for both sides – if the market price rises above the strike price, the buyer of the call option is in profit; if it doesn’t, the seller keeps the price paid for the option and he is in profit.

But look – this ‘other party’ is not some special magic kind of dealer – he is just someone who owns the shares on which he is offering to sell an option. If you have a portfolio of shares, there is nothing to stop you offering to sell call options on your shares. You get an immediate payment for the option, and either you simply keep it, or you have a guaranteed sale price for your shares.

As you might expect, there is a similar situation for put options – someone has to be selling the put options in order for you to be able to buy them.

As a further variation, and somewhat more risky, you can sell an option for shares you do not currently own. This gets you an income from the sale in the short term, but if you are on the losing side of the gamble then you have to go and buy the shares at the current market price.

As you go further into your options trading training, you will begin to understand the risks and benefits, and your trading will move from gambling to sound investment.

If you are going to invest in the stock market, I believe you need a much more hands-on approach than buy-and-hold. Even so, a few hours portfolio management per week beats a full-time job. With a more active approach, investing in the stock market can be a wealth-building programme, not just a place to park your existing funds with a view to a slightly better return than the banks will produce.

There are many different approaches to managing your investments rather than buy-and-hold. One area worth looking at is options trading – when you buy options, you are not acquiring the stocks themselves, you are buying the right to make an agreed trade at some point in the future. This can be used when the stock values go up OR down, by buying the right kind of option. There are 2 basic kinds of options:

Call options – these give you the right, but not the obligation, to buy shares at an agreed price on or before an agreed expiry date. If the actual price of the shares rises above the price agreed in the option, then the holder of the option can make a profit by buying the shares at the option price, and immediately selling them at the higher market price. But there is no need to do this buy/sell transaction, since the option itself has an intrinsic value in this situation and can itself be traded.Put options – these give you the right, but not the obligation, to sell shares at an agreed price on or before an agreed expiry date. If the actual price of the shares falls below the price agreed in the option, then the holder of the option can make a profit by buying the shares at the market price and immediately selling them at the higher option price. Again, there is no need to do this buy/sell transaction, since the option itself has an intrinsic value in this situation and can itself be traded.

Because options values vary with the margin between the market price and the agreed option price, the option prices change by a much greater percentage than the prices of the shares themselves. It is not at all uncommon for options to change 50% in a week – 3 of my last 5 trades have gained over 50% in a week.

There’s a lot to learn about option trading, but for the small investor I recommend taking a look at this as an active investment strategy in preference to the passive buy-and-hold approach.

Selling covered calls is sometimes compared to taking out a limited insurance policy on your stocks, except that you get paid to take out this policy.

How? If you own a stock with options available, you can sell an option to call, (buy), your shares away from you at a given price, known as the strike price.

You’ll receive money, called a premium, for selling a call option. In fact, you’ll often receive a bigger $ amount per share by selling a call premium than you’re currently receiving as a dividend. This money reduces your net cost basis on the stock, hence the insurance analogy.

What’s the catch? By selling the call option, you’re obligating yourself to deliver x amount of shares of the underlying stock at a specific price – the strike price.

Each option contract corresponds to 100 shares of the underlying stock, so make sure that you own at least 100 shares of the stock BEFORE you try to sell calls against it.

Here are a few basic option terms that will help explain this option strategy:

Strike Price: The price attached to a given option contract, that a call seller is obligated to sell the underlying stock at to the buyer.

Call Bid Premium: The amount of $/share that call buyers are currently offering, (Bidding), for a given call option.

Expiration Date: The date that an option expires, which is normally on the 3rd Friday of the option’s contract month.

Option Chain: The listing of options available for a stock. These are arranged by calendar month. Normally, the months available revolve throughout the year: the front (current) month, the next month, one month per quarter, and the following January. Some more heavily traded stocks have more months available simultaneously.

What triggers the sale of your shares when you sell covered calls? If the price of the underlying stock rises to or past the combination of the strike price and the call premium you were paid, your shares will usually be “assigned”, (sold).

If you sold a $15 January call option and received $1.25, your shares would be assigned if the stock rose to or above $16.25.

Assignment normally happens at or near the expiration date.

Assigned Yield: The % yield a call seller receives when his shares assigned, calculated as follows: The difference between his basis cost on the underlying shares and the call’s strike price he sold at, dividend by his cost basis.

For example, if you sold that $15 call, and your cost basis on the stock was $14.00, you’d earn an additional $1.00/share, if your shares were assigned, which would equal an assigned yield of 7.14%. ($1.00 dividend by cost of $14.00).

Call Yield: The yield that the call seller receives for the call, calculated as follows: The call premium divided by the cost basis/share of the underlying shares.

In the above example, the call seller sold a call for $1.25, and the cost basis of the stock was $14.00. Therefore, his Static Yield equals 8.93%, ($1.25 divided by $14.00)

Most covered call sellers compare the amount of dividends they’d receive prior to the call’s expiration, to the amount of call premium they’d receive, to judge if it’s worth selling the call option or not.

Total Assigned Yield: The total of the dividends received, call premium received, and assigned yield received, all dividend by your cost basis of the stock.

In this example, if you’d received $.60/share in dividends during the investment term, plus $1.25 in call premium, plus $1.00 assigned yield differential, you’re total income on the trade would be $2.85, on a $14.00 stock. This equals a 20.36% Total Assigned Yield.

Total Static Yield: This is the combination of the dividends received or qualified for prior to expiration, plus the call premium received.

A Static Yield occurs when the stock DOESN’T rise to a price that is equal to or over the combination of the strike price and call premium, and the call seller’s shares are not sold.

To sum up, you can add up to 2 new income streams to your dividend income on any optionable stock, by selling covered calls against it.

We took a stock with a $.60 dividend, (a 4.3% dividend yield), and earned over twice as much $ in call premiums immediately, $1.25, (8.93% call yield), plus, we positioned ourselves for an additional $1.00/share if assigned, (7.14% assigned yield).