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Basic Options Strategies

An overview of covered calls and married puts.

If you're interested in trading options online, you're not alone. For the last several years the Chicago Board Options Exchange (CBOE), the nation's leading options exchange, reported record trading volume for equity options, driven largely by individual options traders like you.

If you are new to online trading, you should familiarize yourself with two basic options strategies especially suitable to beginners. As always, investors should be mindful of the risks involved in trading options. Multiple leg options strategies involve additional risks and multiple commissions, and may result in complex tax treatments. Please consult a tax professional prior to implementing these strategies.

Covered call writing

This options strategy offers investors a way to earn income on stock they already own. Usually the market for the underlying stock is flat or down, and the investor has already seen some appreciation in their stock position over time. Here's how it works:

Say you own 100 shares of ABC stock, which you bought at 25 but is currently trading at 43. However, in the short-term you think ABC is moving into a slight downturn, and you'd like to earn some income on the position.

You sell 1 March ABC call at 45 for $2, or $200 for the entire position. If ABC's stock price stays around 43, the call buyer probably won't be tempted to exercise his or her right to buy at 45. If that happens, you keep the $2 you earned selling, or "writing", the covered call. Your maximum loss potential is the value of the stock that you own minus the premium you received. Check out our tips for writing covered calls to learn more about this strategy.

Of course, if ABC's stock price goes up to, say 48, that's a different story. The call buyer may very well exercise their right and buy the stock at 45. If that happens, there's a chance you'll get assigned, or be required to deliver your ABC stock for $45 per share. However, even if that happens, it's not too bad for you: after all, you bought your shares at 25.

Married put

This options strategy offers investors a way to buy stock and use put options to protect gains on that stock position. Here's how it works:

You buy 100 shares of XYZ for $30 per share. At the same time, you buy an April XYZ put with a strike price of $27.50. You're bullish on XYZ and hope that its price will rise. However, if that doesn't happen the put offers some protection to the downside. Even if XYZ plummets, you'll still have the right to sell your shares of XYZ for $28 per share, just by exercising your put.

Of course, you also have to pay for that protection by buying the put in the first place, so bear this in mind when using a married-put strategy.

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