Every once in a while I like to review the strategy. I think I will do it in parts so it doesn't get to overwhelming (boring). So in Part 1 we are going to cover the general concept of writing options (also referred to selling options/premium and short options/premium). I think the big guys in Chicago all got together 30 years ago and decided to make trading options as confusing as possible so that the average Joe/Jane would get lost in the terminology before ever getting to the concepts of trading. For instance, a Bull Put Spread has three other names that I know of. Hopefully we can remove the veil of confusion and get everyone comfortable with the concept of writing options.
When we choose to sell an option we are making a commitment or entering into a contract between two or more parties. The commitment comes if the options are assigned. If you sell a call you sell short the stock where selling a put results in buying the stock. Options tend to get confusing for some people when the covered question comes into play. Creating a covered position can reduce the margin on uncovered options and provide a hedge. Writing a call option is a bearish position. Therefore if the stock’s price increases from the entry point the option will begin to lose money. The opposite is true for selling put options. The decline in the stock’s price will bring the probability of assignment higher and thus the premium higher. Higher probability of assignment is reflected in the initial premium as well. If the initial return is higher than historical levels, the option pricing is representing assumed higher volatility and the higher probability that the option will be assigned. Stay tuned for Part 2.