Options can be used to accomplish many things commonly done in ways that add profit.
Using calls to sell a stock
The owner of stock may wish to sell it but not have an immediate need or desire to execute the transaction. For example a stock may be presently selling for $29 per share and its price may have fluctuated recently between $28 and $32 per share. If a market order is executed to sell the stock, its owner can expect to receive about $2,900 for one lot. Since the stock often trades above $30 per share, the stockholder may wish to wait until the price exceeds that level before selling. Rather than waiting until the price goes above $30 and then executing an order, a limit order may be entered. The limit order allows the stockholder to ignore the minute to minute pricing of the stock. Such a limit order would specify that the stock be sold when the market price equals or exceeds $30 per share.
Another alternative would be for the investor to employ a call. If call options are being traded for that security, the investor might simply sell a call with a $30 exercise price. Such a call with slightly less than one month until expiration might be selling in the market for 75 cents per share. The investor would receive $75 less the commission for the sold call. Then upon expiration of the sold call, if the stock’s market price exceeds $30, the call will be exercised. Thus the investor will receive an additional $3,000 for a total of $3075 to sell the shares. If the stock’s price is under $30 per share at expiration, the sold call option will expire worthless and the investor merely keeps the $30 premium earned for selling the call. Immediately thereafter another call with the same $30 exercise price can be sold for the next month. As long as the price remains somewhere near the $29 level without exceeding the exercise price of $30 at expiration the investor can continue to collect the premium of about $75 every month. Eventually the shares will sell and the investor receives the $3000 selling price.
This approach obviously is not suitable to the investor who wishes to sell immediately or even soon. However a modest modification can be used to increase the probability of selling the shares at expiration. Rather than using a $30 exercise price for a stock that is selling around $29 a lower exercise price might be chosen for the call to sell. For example, a call option with a $25 exercise price and a premium of $4.25 might be sold. This effectively amounts to selling the stock for modestly more than its immediate market price. The sum of the $4.25 premium and the exercise price of $25 produces a total price of $2925 for a stock that otherwise could only be sold for $2900. The investor in this situation gives up the extra gain that might be available with a higher exercise price, but realizes an essentially immediate sale with modestly more return than would otherwise be received. Although the magnitude of the earned bonus is quite small in this example, an investor selling 1000 shares would receive an additional $250.
Using puts to buy a stock
Often people execute limit orders when they wish to purchase a stock. For example a stock that is immediately selling for $32 per share when somebody enters an order may have bounced around between $29 and $35 per share for some time. If a prospective buyer wishes to buy that stock and is patient, he may watch it and simply enter the buy order when it drops to or below $30 per share.
