Selling option premium is a great way to generate income inside of your investment portfolio, and lower your cost basis on a position. But if you aren’t careful, these mistakes can cost you a lot of money.
- Selling to close to the money
- Buying back at a loss
- Not paying attention to the expiration dates
- Not looking at upcoming earnings/dividend dates
- Not double checking charts
Selling to Close to the Money
Selling too close to the money is a very aggressive strategy. You need to be very certain of a specific direction to employ this strategy. If you are selling calls right at the money, you risk your shares being called away. Unless you are wanting to get rid of the stock, it is generally not worth the risk. You would want to go up a few options to give yourself a cushion. On the put side, I will only sell right at the money if I want to purchase at that specific strike price. I will take the chance that the stock goes lower in exchange for the premium. This lowers my cost basis right out of the gate.
Buying back at a loss
You should never buy back a covered call or put at a loss. When you open a position on either a cash secured put, or a covered call you set the price, the date, and the amount of of contracts/shares. That means that you have almost all of the control, you are the house. If the stock moves against you you can try to roll the position out to a further expiration or take assignment. But you should avoid buying back at a loss. Unless your analysis of the stock has changed, then take assignment and look for a re-entry by using the wheel strategy.
Not paying attention to expiration dates
Depending on how many positions you have that you are selling premium on, and what time frame you are selling, the different contracts can become a lot to keep up with. Failing to roll a position can result in the stock being called away from you, or assigned to you. Potentially at an unattractive price.
Not looking at upcoming earnings/dividend dates
Earnings/dividend dates can make a big difference in the underlying stock price, and can also impact your options. The general rule of thumb that I follow is to just open more conservative contracts during both the week of earnings, and any upcoming dividends. After all, for me personally the point of this strategy is to lower my cost basis on the underlying stock overtime, not have the shares constantly called away from me. If good earnings come out, and you have an aggressive covered call open, then you could be sacrificing potential gains on the underlying stock.
Not double checking charts
I myself enjoy looking at both stock financials and charts. Both aspects of stock analysis can give you great insight into what is going on with specific stocks. Now I am not going to get into the debate between fundamental analysis and technical analysis. Depending on your trading/investing style both have their place. But there are certain charting features that can at least let you see what the trends are in certain companies. Using these trends you can see if a stock is trending up or down. It is important to confirm your exits and entries with charts.
Utilizing these tips while selling option premium can help maximize premium in the long run. No matter what your reason for selling option premium, you want to make sure that you are not being too aggressive on your strike price, never buying back at a loss, paying attention to your expiration dates, looking at upcoming earnings/dividend dates, and double checking your stock charts. Selling option premium is an advanced trading strategy that can help you lower your cost basis and add income to your stock portfolio. But it done incorrectly selling premium can result in costly mistakes that may wash out any gains you have.
