Options are derivatives. They have been around for decades now and are very well understood by the financial elite and indeed many savvy retail investors. They are traded on exchanges just like shares and are based on an underlying asset such as a stock, index, or future. In other words, their value is derived from the underlying asset. Hence, the term ‘derivative’.
If you buy an option you have the opportunity to buy or sell the underlying asset at a given price within a given time frame. This can be a great way to make a leveraged investment in a stock that you believe is going to go up or down.
However, many investors — including FIRE Revolution aficionados — generally prefer to sell stock options. The reason is that you are paid a premium for selling the option in return for taking on the associated obligation to buy or sell shares at the agreed strike price for a limited period of time.
So, if you predetermine the price that you are happy to buy or sell the shares at, then selling the option obligates you to stick to that commitment if the buyer chooses to exercise their right. In effect, you are setting up a limit order to sell or buy shares at a fixed price BUT you are being paid a premium to do so. And that premium is yours to keep whatever happens.
You can often sell multiple consecutive options on a particular stock without being assigned and that allows you to build up quite a substantial pot of premium. That cash can then be withdrawn as income, reinvested, or even used to offset any drop in the share price. Hence, the fact that selling stock options is actually safer than simply buying shares outright.
Options are available on a number of underlying assets but here at FIRE Revolution we focus on stock options and specifically on stocks that we are happy to own long-term. So, we select the stocks we like in the first place and then use an elegant stock option strategy to control our entry and exit from those shares whilst all the time generating a substantial dividend-like income stream.
If you’d like to learn more than please check out my description of Cash-Secured Puts and Covered Calls.