Nutricove

A quick refresh

In Level 5 you met . One contract usually covers 100 shares, so a of $1.00 costs $100. Every option has a and an expiration date. The buyer gets a choice. The seller gets paid the premium but takes on a duty: if the buyer uses the option (), the seller must do the deal.

None of the three strategies below is "safe." Each one trades one kind of risk for another.

Profit or loss on expiration day for the three examples in this lesson. In the first chart, the dashed line is owning the stock alone.

1. The covered call

A means you own 100 shares and sell a call on them. It's like renting out your bike: you get paid now, but if your friend wants to buy it at the agreed price, you have to sell.

Example: you own 100 shares bought at $50. You sell a call with a $55 strike, expiring in a month, for $1.00. You collect $100 right away.

Stock ends at $52: below $55, so the call expires worthless. You keep the $100 and your shares.
Stock ends at $60: your shares get bought from you at $55. You make $5 a share ($500) plus the $100: $600. But owning the stock alone would have made $1,000. Your upside is capped.
Stock falls to $40: your shares lost $1,000. The $100 helps a little: -$900.

The is $49. Works when the stock drifts sideways or slowly up. Hurts in a crash or a big rally.

2. The cash-secured put

A means you sell a put and keep enough cash ready to buy the shares. It's like promising to buy a friend's video game for $45 if they ever want to sell, and they pay you a little for that promise.

Example: a stock is at $50. You sell a put with a $45 strike for $1.00 and collect $100. You set aside $4,500, enough to buy 100 shares at $45.

Stock stays above $45: the put expires. You keep the $100.
Stock falls to $40: you must buy 100 shares at $45 ($4,500), but they're only worth $4,000. Minus the $100 you kept, you're down $400.
Stock falls to $35: you're down $900.

The break-even is $44. The most you can make is $100, but the stock can fall a long way. Works when the stock stays above the strike.

3. The vertical spread

A means you buy one option and sell another of the same type and date, at a different strike. This example is a bull call spread, for a stock you think might rise.

Example: a stock is at $50. You buy a $50 call for $3.00 and sell a $55 call for $1.00. Your cost is $2.00, or $200.

Stock at $50 or below at expiration: both calls are worthless. You lose $200, the most you can lose.
Stock at $52: your $50 call is worth $2, which is $200. You break even.
Stock at $55 or above: the spread is worth $5, or $500. Minus your $200 cost: +$300, the most you can make.

It costs less than the call alone and you know your worst case up front, but your profit is capped. (A bear put spread is the same idea with puts, for a fall.) Fails when the stock doesn't rise enough before expiration, because options lose value as time passes.

Risks to know

Selling options means duties. Most US stock options can be assigned on any day before expiration.
Spreads can lose their whole cost, and you pay fees on both options.
Options accounts are for adults, and brokers have to approve them.

Like every strategy in this level, test any options rule first, on paper or old data. Level 8 shows how.

Remember

One contract is usually 100 shares, so a $1.00 premium is $100.
A covered call earns a little now but caps your upside, and you still own the stock's risk.
A cash-secured put earns a little now but can make you buy a falling stock.
A vertical spread caps both your loss and your gain.

Money Tree School is education, not financial advice. Examples use made-up or historical numbers to show how things work; they are not recommendations to buy or sell anything. Markets can lose money.