In this strategy, we are not interested in "trading options" , we are merely after a predictable stream of monthly income .. trading options involve assessing risks using delta, theta , vega etc, which means we have to be able to reasonably predict the direction of the underlying stock.. we are not particularly interested in that.. in fact, if we are correct in our analysis, we will make money regardless of the movement of stock in either direction..
the strategy involves selling ( writing ) deep out of the money put options on good stocks.. to clarify, when u sell options, u receive a premium ( how much? this depends on the strike price, volatility and time of expiry as calculated by black scholes options pricing model, which u dont need to know ) ..
What is selling put options mean? it means u r telling someone ( an option buyer) that u will buy his stock if the price of the stock falls below a certain price ( strike price).. for example, assume a stock is trading at $60 a share , u will tell someone that u will buy his stock during a certain time period( say 1 month),if the price of stock falls below say $50 at specified predetermined amount of $50 ( which is called a strike price ).. in compensation u demand a option premium of lets say $5 a share.. so if at the end of the option time period, the stock is trading at $45 , u will buy it at a price of $50..
this is a form of selling insurance to the put option buyer and u making an income out of it .. good news is that majority of put options expire worthless..
that means majority of the time, ull collect premium income without any hassles ...
up coming next :
1) how to identify good stocks to base this strategy on?
2) how to determine the optimum strike price for your option ( using discounted cash flow analysis ) ?
3) what to do when the option is exercised and ur obligated to buy the stock from the option buyer .. good news? u will still make money from it..
thats it.. happy trading..