Options are a type of financial instrument known as derivatives. This means their value is based on (or “derived” from) something else—usually a stock or index. Think of options like a coupon that lets you buy or sell something at a set price before a certain date. Just like a coupon at the store, the option itself has value, even if you don’t use it.

A Simple Analogy: Renting a House Instead of Buying

Imagine you want to buy a house, but you’re unsure if the price will go up or down. Instead of purchasing it outright, you negotiate a deal with the owner: for a small fee, you get the right to buy the house at today’s price within the next six months. If home prices rise, you can buy at the lower price and instantly gain value. If prices fall, you can simply walk away, having only lost the small fee. That’s how options work—you pay for the right, but not the obligation, to buy or sell an asset at a fixed price.

Calls and Puts: The Two Types of Options

There are two main types of options:

• Call Option = The right to buy an asset at a set price before the expiration date.
• Put Option = The right to sell an asset at a set price before the expiration date.

Each option has two sides: a buyer (long position) and a seller (short position). The buyer pays a premium to have the right to buy (call) or sell (put) the asset, while the seller (short position) collects the premium but has an obligation to fulfill the contract if exercised.

Option contracts have an expiration date. The longer you hold these contracts they can decrease in value. The stock price has to move for the option price to go up in value. So they can be risky since a stock can go up, go down, or trade sideways. There are strategies to make money in each of these scenarios. When an option contract loses value due to lack of movement over time, this is called time decay.

Going Long vs. Going Short

• Going Long (Buying an Option):
  • When you buy an option, you have the right (but not the obligation) to buy (calls) or sell (puts) the underlying asset.
  • You pay a premium for this right.
  • Potential for unlimited gains with limited loss (only the premium paid).
• Going Short (Selling an Option):
  • When you sell an option, you take on an obligation to buy (puts) or sell (calls) the asset if the option is exercised.
  • You receive a premium upfront.
  • Potentially large losses, but can generate income.

The Leverage of Options: Controlling 100 Shares

One of the most exciting parts of options trading is leverage. When you buy a stock, you own one share for every dollar you invest. But with options, a single contract controls 100 shares of stock. This means small price movements can lead to large percentage gains (or losses). Because of this, options allow traders and investors to potentially make more money with less capital.

Creating Exponential Returns

Since each contract controls 100 shares, a small increase in the stock price can result in large percentage returns. For example, if a stock price moves up 10%, an option contract might increase by 50% or more depending on the expiration date. This is because options magnify price movements, making them powerful tools for both trading and investing.

How to Use Options as a Strategic Investment

Protecting Portfolios with Options

Buying Puts as Portfolio Insurance

Buying a put gives you the right to sell a stock at a specific price, like insurance for your portfolio. If you own a stock and fear a market downturn, buying a put lets you sell your shares at a fixed price, protecting against large losses.

Using Protective Puts to Limit Losses

A unit put strategy involves buying both shares and a put on the same stock. This ensures that if the stock falls, the put option offsets the losses, limiting downside risk while still allowing for upside gains.

Generating Income with Options

Selling Covered Calls for Steady Cash Flow

A covered call strategy involves selling a call option against stocks you already own. This generates income, but if the stock rises above a certain price, you must sell at that price. This is a great strategy for investors looking to earn passive income on their holdings.

LEAPs: Long-Term Options for Investors

LEAPs (Long-Term Equity Anticipation Securities) are options with expiration dates far in the future (up to three years). They allow investors to gain exposure to stocks at a fraction of the cost while benefiting from long-term price movements.

Trading Options for Short-Term Gains

Spreads: Reducing Risk While Trading

An option spread involves buying and selling different options at the same time. This reduces risk and limits both potential gains and losses. Spreads are great for traders who want to control exposure while taking advantage of stock movements.

Day Trading Volatility and Leverage

Options allow traders to capitalize on short-term price swings. Since they move faster than stocks, day traders use them to profit from market fluctuations within hours or minutes. However, this requires knowledge, discipline, and patience due to the high risk involved.

Swing Trading with Options

Swing trading involves holding options for days or weeks to profit from expected moves in stock prices. By using options instead of stocks, traders can amplify returns with lower capital investment.

Profiting in Any Market Condition with Options

Making Money in an Up or Down Market

Unlike stocks, which require prices to go up for profits, options allow you to profit whether markets rise or fall. Buying calls profits from rising stocks, while buying puts makes money when stocks decline. This flexibility makes options powerful in any market environment.

The Wheel Strategy: Passive Income and Stock Accumulation

The Wheel Strategy combines selling cash-secured puts and covered calls to generate income while acquiring stocks at a discount. Investors sell put options on stocks they want to own. If assigned, they buy the stock at a lower price. Then, they sell calls to generate more income. This cycle repeats, producing steady cash flow.

I utilized this strategy almost exclusively in 2022. I did it using leveraged and inverse ETFs like TQQQ and SQQQ, so it moved three times as fast as the regular market. I made an annual return of 42% in a down market. I think I would have done even better if had more experience trading this strategy. Its risky if you don’t know what you’re doing. If you just want better prices on your stocks, you can learn how Warren Buffett used options strategically to acquire Coca Cola shares.

How Insurance Companies Use Options for Growth with Low Risk

Recently, insurance companies have integrated long-term options contracts into their investment strategies. By using options, they achieve higher returns while keeping risks low. For example, they may use protective options to hedge against market downturns, ensuring steady and reliable gains for policyholders. This strategic use of options enhances returns while safeguarding assets. This is why cash value life insurance policies can offer better than average returns for people looking at alternative asset classes.

Why Doesn’t My Financial Advisor Use These Strategies?

That’s a question we hear all the time—usually right after someone learns how options can reduce risk, increase income, or protect against market downturns. The short answer? Your financial advisor probably doesn’t use these strategies because they don’t know how.

Most traditional financial advisors are trained to sell products, not build strategies. If your advisor sold you a portfolio full of mutual funds, ETFs, or managed accounts and calls it “diversification,” there’s a good chance they’re functioning more like a salesperson than a strategist.

Here’s the truth: the financial licensing exams touch on options—but only at a surface level. They cover what options are, but don’t go into great detail on the myriad of strategies. There’s no real training on tactical use, no focus on income-generating spreads, hedging, or adjusting positions. So unless an advisor has gone well beyond standard licensing and done the work to study and apply options strategies, it’s not something they’re likely to use—or even recommend.

And here’s why that matters: most advisors make money by managing your money. The more assets you hand over, the more they earn—whether you profit or not. They have no financial incentive to go outside that box or to learn techniques that don’t align with the traditional “buy and hold” model.

Bottom line: if your advisor isn’t talking to you about strategies like covered calls, protective puts, or spreads, it’s not because they’ve evaluated them and decided they’re not a fit. It’s because they likely never learned how to use them in the first place.

I have a degree in finance and learned about options in college but it has taken me years of study to learn how to use them strategically. Some of the strategies I’ve used were deemed very risky by professors, like selling puts, so I didn’t use them until I learned they were wrong. Options are only risky if you don’t know what you’re doing. In fact the whole point of options is to reduce risk. Knowledge is the key. For most investors, selling covered calls and buying unit puts would probably be sufficient to reduce their risk and make some extra money using their current portfolio.

Conclusion: Why Options Are a Must-Know Investment Tool

Options provide unique advantages over traditional investing. They offer leverage, allow investors to profit in any market condition, generate income, and protect portfolios from downside risk. Whether you’re a long-term investor, a short-term trader, or someone looking for additional income, options are a strategic investment tool that can help you reach your financial goals.