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So far, I have been talking about how good selling options is to earn monthly passive income. But, we all know any type of investing comes with risk. Selling options also comes with its own risk.

Today, we are going to take a look at all the hidden risks associated with options selling.

How Options Selling Really Works

Before that, let’s briefly revisit how options selling really works.

There are two types of options:

• Call Options – it gives the option buyer the right to buy the stock at an agreed fixed price at an agreed date in the future.
• Put Options – it gives the option buyer the right to sell the stock at an agreed fixed price at an agreed date in the future.

When you sell options, the options buyer pay you money(i.e. premiums) upfront.

If the option expires worthless by the expiration date, you keep the money for free. However, if the option is exercised by the option buyer, you will have the obligation to buy/sell the stocks at the agreed price.

Let’s look at an example.

A stock option contract is an option to buy/sell 100 shares of the underlying stock.

Today is 11th Oct 2017. Let say the 20 Oct 17 $155 PUT for Apple Inc is worth $1.25.

If you sell 1 PUT option, you will get paid $1.25 x 100 = $125

Now, you have $125 in your pocket.

There are two possible scenarios:

Scenario 1: The market price of Apple Inc rises above $155 on 20 Oct 17.

In this case, the option expires worthless.

Why?

The option contract gives the option buyer the right to sell Apple Inc at $155 per share. But, the option buyer can easily get a better selling price in the stock market since the market price is above $155.

There’s no point for the option buyer to exercise the option.

Results: You keep the option premiums for free.

Scenario 2: The market price of Apple Inc falls below $155 on 20 Oct 17.

In this case, the option buyer will exercise the option.

Why?

Because the option buyer can sell Apple shares at $155 per share while the market price for Apple is below $155.

In other words, the option buyer gets a better selling price by exercising the option contract.

When the option is exercised, you will have the obligation to buy the Apple shares at $155 per share even though the market price at that time is less than $155 per share.

If you are new to options selling, here’s a FREE Options Basics Boot Camp that I recommend. 

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What Are The Hidden Risks Of Selling Options For Monthly Income?

So, what are the hidden risks of selling options for monthly income?

Possible Risk #1: The stock price goes down to zero

When you sell PUT options, you have the obligation to buy back the stocks at the agreed price when the option buyer exercises the option.

Let’s continue with the Apple Inc example above.

You sold one 11 Oct 17 $155 PUT option for Apple Inc, and you got paid $1.25 x 100 = $125.

9 days later on 20th Oct 17, the Apple share price dropped to zero.

The option buyer exercised the option.

That means you had to buy 100 Apple shares at $155 per share even though the market price for Apple has dropped to zero.

This is the worst kind of scenario for selling PUT option.

The stock price will only fall to zero when the underlying company goes bankrupt.

Here’s the good news.

There are always warning signs that you can look out for when the underlying company is in trouble.>

For example, their earnings fall short of expectations or they are unable to meet their debt obligations.

Companies hardly just go bankrupt all of a sudden without any warning signs.

Possible Risk #2: The stock price keeps going down

What if the stock price just keeps going down?

Let’s use the same Apple Inc example.

You sold one 11 Oct 17 $155 PUT option for Apple Inc, and you got paid $1.25 x 100 = $125.

9 days later on 20th Oct 17, the Apple share price dropped to $150.

The option buyer exercised the option, and you had to buy the Apple shares at $155 even though the market price at that time is $150.

So, you are holding 100 Apple shares with a cost price of $155-$1.25 = $153.75.

Here, you use your option premiums to offset your cost price to lower your break-even price.

If the Apple share price goes up to $153.75, you will be able to break even.

But, what if the Apple stock price keeps going down?

If the Apple stock price keeps going down, one way to salvage the trade is to sell covered CALL options.

With the premiums collected from selling covered CALL options, you are able to lower your break-even price further.

Will the stock price never go back up again?

Unlikely.

Why?

First, stock market goes up and down.

But, it generally goes up over time.

After 2008 financial crisis, stock market recovered quickly and is now making new highs.

Similarly, the stock market rebounded after the great depression in the 1930s.

 

From the chart, you can see that the stock market has an upward bias and always go up over time.

So, if you choose a company that has good fundamentals to sell options on, chances are that the share price will eventually rebound and you will be able to get out of the trade even with a decent profit.

Recommended Resources To Help You Sell Options Profitably:

To sell options profitably, you need to be able to do the following:

• Identify the Right Stocks for options trading
• Know when to enter and exit, manage your options trades

INO MarketClub is a powerful trading software that helps you find the strongest trending stocks (i.e. uptrend or downtrend) as well as tells you exactly when to enter and exit.

With this tool, you can easily identify which stocks are good candidates for options trading and when and where to enter and exit.

With this information, you can leverage options trading to earn passive income safely.

For example, if a stock is trending up, you can choose to sell PUT options.

If a stock is trending down, you can choose to sell CALL options. 

So, how does MarketClub work?

There are two powerful features:

• Smart Scan (i.e. it allows you to choose from 24 different scans which are all specifically designed to find stocks with the strongest trend)
• Chart Analysis Score (i.e. it measures trend strength and direction and will dynamically update)

Here’s an example of how you can view the positive Chart Analysis Score:

50 to 65 : Trading Range (i.e. moving sideways)
70 to 80 : Emerging Uptrend
85 to 100 : Strong Uptrend

For me, I am always looking at Chart Analysis Score of at least 85 and above for buying opportunities and a score of at least -85 or below for shorting opportunities. 

Why?

Because it gives me trade opportunities with the highest probability to win.

So, how does MarketClub tell its members where to enter, exit, and when to sit out and wait?

It uses what it calls “The Trade Triangles”.

Here’s how it works.

Green Trade Triangles signify uptrends.

Red Trade Triangles signify downtrends.

Together with the Smart Scan, it can help you identify the strongest trending stocks with the exact entry and exit signals. 

With this information, you can leverage options trading to earn passive income safely.

For example, if a stock is about to go on an uptrend, you can choose to sell PUT options.

Register For Your Options Basics Boot Camp For FREE