I just submitted an Options Agreement to the operations department at the branch where my Morgan Stanley brokerage account account is held; this is a required document (along with acknowledgment that I have received the “Characteristics & Risks of Standard Options” from CBOE (the Chicago Board Options Exchange) and the OCC (Options Clearing Corporation).
Assuming that I am approved for options trading, I will be able to earn a little extra income on any of my long equity bets by selling (or “writing” in the nomenclature) covered call options. This entails selling someone the right to call my shares away from me at a set price. As long as the price of the stock does not go above that set price (called the “strike”) then when the option expires I get to keep any premium that I received for selling the option contract.
If the price of the option does go above the strike price, then I would effectively be selling my shares for that price and incurring any gain or loss based on the difference between the strike price, and my original cost-basis plus I’d keep any of the original premium received.
I will also be able to buy put contracts. These types of options are like an insurance policy, I’m buying the right to make someone else take my shares at the given strike price. If the price of the stock falls below the strike, then I’m essentially locking in a sales price. This strategy is used to attempt to prevent significant losses in a falling market, but still allowing for an unlimited possible gain. If the option expires unexercised, then I will have lost my premium, but will still own the security and will be able to realize gains if/when the underlying shares are sold.
Now, I don’t expect that I’ll be writing too many option contracts currently, considering how volatile the market still is, and that my equity portfolio is still rather small, but I figure it’s best to plan ahead … and when I do start trading options, initially it will be the income and hedging strategies described above. Speculative strategies will come later, after I get more comfortable trading options.