Because options contracts are a decaying asset, selling covered calls or cash-secured puts can help investors generate additional income within their portfolio using this time-value decay. 

Covered calls and cash secured puts are widely used options-based strategies for investors who want to potentially enhance returns by collecting the premiums from selling these options. They can also be useful for other investment objectives, besides additional income. 

For example, a covered call can hedge against short-term losses in a long stock position, and a cash secured put can provide a way of buying the stock below the current market price (provided that the premium received is larger than the difference between market and strike).

Probability of OTM at Expiration

The difference between the strike price of the option you sell and the underlying stock's current price can significantly affect the risk/reward profile. This presents a critical decision for the option seller. Do you select a strike price that's the same as (or close to), higher, or lower than the current stock price? Referring to the "Prob. OTM" indicator can help you decide.

Probability is the likelihood of an event happening within a specific period, usually expressed as a percentage. In this tool, the event we're gauging the likelihood of is an option expiring in the money (ITM) or out of the money (OTM), and the time frame is the time until the expiration date. Webull users can refer to the "Prob. OTM" number to see an estimate of the probability that an option will be out of the money at expiration.

Suppose you sell a covered call on ABC stock with an "ABC $180 Sep 16 22 Call" because you want to collect an extra $116 income from your ABC shares. There is a probability of 83% that your option will expire out of the money, which means that you have an 83% chance of retaining the premium you received from selling the option without taking on additional obligations. If the premium changes, you can buy back the call option before expiration to realize any potential profit or loss accrued.

NOTE: The calculation of OTM probability is based on the probability distribution of the stock's market price. It represents a theoretical value for reference only and does not guarantee the option actually becoming OTM. Even if an option has a Probability OTM of 100%, there's no guarantee the option will finish OTM at expiration. There's always a chance, even if it's a small one, that the underlying security could move enough that a deep OTM option converts into an ITM option.

There is a wide range of market attitudes on many stocks, leading to a diversity of strike prices at which you can sell options. Usually, the further OTM an option is, the lower its premium will be, and the further ITM it is, the higher its premium will be. This presents a possible tradeoff for option sellers—you can collect higher premiums on options with strike prices that are ATM, ITM, or simply not as far OTM as they could be, but with these higher premiums comes increased risk of assignment.

Tradeoffs in Liquidity

In the more active markets, increased participation makes buying or selling an asset easier without affecting prices too much. In financial jargon, we say that such investments have liquidity. All else being equal, the more liquidity a contract has, the more flexibility there is for both its buyers and sellers.

Two crucial indicators can help you size up liquidity in options trading: volume and open interest.

l The daily volume of options is the number of contracts traded on a particular day. For instance, a ticker that sees a daily volume approaching 1 million contracts is among the more liquid. On the other hand, if just a few hundred contracts are traded, the underlying security may not have ideal liquidity.

Open interest is the total number of options positions that remain open—meaning the contracts have not been sold back or exercised by their buyers—on a particular day.

For any specific contract, other things being equal, ATM options are usually among the most actively traded. This is primarily because uncertainty is higher for ATM options than ITM or OTM options. For ATM options, even a slight price movement in either direction can tip the option from ATM to ITM or OTM.

Higher volume and open interest typically lead to a tighter bid-ask spread. Why is it important to consider the bid/ask spread? Because it may incur a potential loss for the seller. To explain further, let's use the example below:

Since the volume and open interest is higher in ATM options than in OTM/ITM options, the spread of ATM options is tighter. The tighter the spread, the better chance of getting filled at a better price or entering/exiting trade quickly. In conclusion, it is important to consider the bid/ask spread when trading options, as this can significantly impact the trade outcome.

Consider Your Options

The covered call and the cash-secured put can be useful strategies for investors to explore as they build their portfolios. Now, you understand how strike selection may influence your risk and reward profile in options trading. Options strategies are about tradeoffs, and it all comes down to your objectives and risk tolerance.