For every options buyer, there has to be a seller. Options sellers (also known as options writers) earn the premium the buyer pays for a given option. Selling options can be a good way to generate income in a sideways market.

The options seller's only wish is that the buyer is wrong – that the underlying stock will rise or fall when selling a put or a call.

Covered vs. uncovered

There are two types of options sales — covered and uncovered. If you own the stock you are selling calls or puts on, then your position is covered. If the buyer is right and exercises the option, you can deliver the stock.

If you don't own the stock on which you're selling calls or puts, your position is considered uncovered or naked.

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Selling covered calls

As the seller of the option, you have no rights. The option owner may, or may not, exercise the option. If he does exercise, you have no control over the timing, and will receive an assignment notice. At that time you must sell the stock for the exercise price.

Scenario 1: The option is in the money. You'll receive an exercise notice the next Monday morning, before the market opens. You sell your shares to the buyer. But, you also keep the premium that you received when you sold the option.

Scenario 2: The option is at the money. It is up to the buyer whether or not he wants to exercise the option. You will get a notice to sell the next Monday morning if the buyer exercises the option. If you get a notice, you must sell the stock. If not, you can keep the stock. At which point you can either sell another option or just hold the stock. And, you always keep the premium.

Scenario 3: The option is out of the money. The buyer will not want to buy your stock – he could buy it on the open market for less. So, the buyer lets the option expire worthless. You hang onto the stocks and the premium. And you can always use the shares to sell another covered call option.

Selling covered call options is a safer investment strategy than owning stock alone. That's because you earn premium income that offsets a portion of your loss should the stock decline. You can even make money if the stock doesn't move at all. However, your profit potential is limited.

Important: The following strategies are less common and not recommended for novice options traders.

Selling covered puts

This strategy is less common than selling covered calls, but works the same way. You sell short 100 shares of stock, and sell a covered put on the shares. Like covered calls, the maximum profit is limited.

Caution: The potential loss is unlimited when selling covered puts, as there is no limit to how high the short stock can rise.

Selling uncovered calls

Like selling covered puts, uncovered calls also have an unlimited risk of loss, and your maximum profit is limited to the premium you receive.

Uncovered calls are an obligation to sell the underlying stock at the strike price no matter what. Since you do not own the stock, you must eventually buy it to satisfy the obligation. If the stock continues to rise, your losses increase.

Caution: There is no limit to how high the stock price can go, and there is no limit to your potential loss.

Selling uncovered puts

Selling uncovered puts, though, have a limited risk and a limited profit maximum. Still, as with an uncovered call, you have an obligation to buy the underlying stock at the strike price. If the stock declines further, your losses increase.

Caution: Because the stock price cannot go lower than zero, you know in advance the maximum amount you can lose. But, it can still be a hefty loss.

When it comes to selling options, stick to selling covered calls. They can be a good tactic to gain income on existing stock holdings, especially if you think that the prices on those stocks will stagnate.

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