How to Trade Options to Complement a Buy & Hold Strategy

So, very basic, what is an option, anyway? Well, there are two types of options. A call option and a put option. It’s important to know that both call options and put options are really just building blocks to different options trading strategies. The idea of just buying a call or just buying a put isn’t really something that’s done largescale by investors who know what they’re doing. So, when you’re learning about calls and puts, and maybe the risk seems a bit high or you’re confused about why anyone would invest in a depreciating asset, just know that you’re at the beginning stages of learning a skill set and certain tools -- these calls and puts -- are to be used in concert with other tools as part of a bigger strategy.

So, when it comes to options trading, there are calls and there are puts. But to help you understand puts a little better, I think it’s first important to understand the concept of Shorting a stock. Shorting a stock is when you sell the stock to OPEN the position. It’s a strategy used if you are Bearish on the stock, or you think it will go down in price in the future. If you saw the movie, “The Big Short,” those guys were betting that the housing and financial industries were going down. Now, Shorting is not quite as intuitive to understand as simply buying a stock, because the mechanics of that are very similar to the real world. If you think that a house is in a part of town that is poised to go up in price, you could buy the house hoping the price goes up in the future. But, if you think a natural disaster would devastate that part of town and make the housing prices go down, you can’t exactly sell a house that you don’t own.

When you buy a put, you are purchasing a contract that says you will sell 100 shares of a specific stock at a specific price on a specific date. Because you are agreeing to sell shares of a stock, that means that you buy a put when you think the price of the underlying stock will go down. It is a bearish strategy. It’s a little less intuitive than buying a call. When you buy a call you are buying a contract to later on buy shares. When you buy a put, you are still buying something, but you are buying an agreement to sell shares. So don’t let that confuse you.

So let’s talk about selling a call. When done by itself in isolation it’s called selling a naked call and this is something I would really advise against. Like, really. I’ve never done this myself and I don’t ever really plan on doing this. To clarify, I do sell calls all the time, but it’s always part of a bigger strategy that cuts my risk. I do not sell calls by themselves. It’s one of the riskiest strategies there is.

Selling a put is a bullish strategy, you want the stock to go up, and it technically has a limited, although still very sizable risk.

I’d also like to spend a little bit of time talking about the strategy of selling puts, not just the mechanics of it, because it is often used in a slightly different way than our other basic strategies. So we just learned that we sell puts when we are bullish on a stock’s future, we want the stock to go up. But the reason many people sell puts is to actually go long a stock at a cheaper purchase price.