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The Rich Have More Options

An old Roman playwright, Plautus, is credited with the saying “You must spend money to make money.” A little thought reveals that the only people who can take advantage of this advice are those who already have some money. This is especially true when investing. You have to already have some money saved if you want to make money through investing. In addition, the more money you have, the more ways you have to make more money.

If a brokerage considers you experienced enough with buying and selling stocks (had an account over a year) or have enough money (over $100,000 or so), they will allow you to trade options. There are different levels of options trading that you can qualify for with each succeeding level having a higher risk level than the previous level. The SEC describes this here:

If you really become rich (the most common path is to have a net worth over $1,000,000), you can qualify to be an accredited investor ( Accredited investors are allowed to invest in things that are not open to the general public. These include things like venture capital, pre-IPO companies, hedge funds, and REITs for specific development projects. These high risk investments also promise much higher returns. For instance, a good venture capital fund is expected to provide a 6X return over 10 years (that is almost a 20% annual return). The rich do get richer.

By the time you qualify to be an accredited investor, many FIRE savers would have already reached their goal. But, almost all FIRE savers will qualify for options trading at some point along the way. If you are willing to accept more risk, options trading can boost your rate of return by a few percentage points per year. Please keep in mind that options trading is a huge step up in risk over just buying and holding stocks for the long term. I would recommend that anyone considering options trading read the following: Losing $58,000 in a week could easily set your financial independence plans back by years.

If you are willing to accept higher risk of options trading, there are options strategies that have less risk. The most common way to lose more than you invest is to borrow money to make the investment, and options trading is is essentially borrowing money. Each options contract is an obligation to buy or sell 100 shares of the underlying stock at an agreed upon price at some date in the future. If you do not own the shares or have enough cash to buy the shares, you are borrowing money and the rest of your holdings in the account are collateral for this loan. If something goes wrong, the brokerage will sell whatever it needs to in your account in order to make good on the loan. If you do not have enough money in the account, they will close the account and start a collections process to collect the balance of what you owe.

The following discussion assumes you know the basics of options trading. If you do not, please read the following first: One method of options trading that can boost your current income is to sell covered calls. A call is the right to buy a stock at a certain price (the strike price) between now and the options expiration date (be aware that this works slightly differently for indexes or for options traded in Europe). A covered call means that you already own enough shares of the stock to satisfy the option trade, So, if you own 1,000 shares of a stock, you can sell up to 10 options contracts on that stock and still be covered. The idea is to sell a call option (right to buy) to someone else at a strike price (the agreed upon future price) that is higher than the current price of the stock. You will immediately collect the money from selling the call option. Then, 1 of 2 things will happen: the option will expire worthless, or the option will be exercised. If the option is exercised, you will end up selling the stock at the strike price (you will also be charged a commission for this sale).

The reason why someone would buy the call option from you is that they believe the price of the stock will increase by more than the cost of the option,. If they are correct, they will exercise the option and make money. You will also make money: from selling the option and also selling the stock for a higher price than it was at the time you sold the option. However, if the price of the stock rises a lot, you would end up making less money than if you had just held on to the stock.

The danger in selling call options on stocks you own is that it prevents you from selling the stock as long as the option has not expired. There is an opportunity cost of not being able to sell and buy something better. There are also many stories of people who have sold covered calls and then watched as the price of their stock plummeted. However, this is not really a consequence of selling covered calls. If the price of a stock starts to drop, you can always buy back the call options to remove your options obligations. At that point, you are free to sell the stock as you wish. Any reluctance to buy back the options and sell the stock are really due to the stubbornness of the stock owner and not inherent in the options trade itself.

The other downside to selling covered calls is that you might end up being forced to sell your stock. The simple answer is that if you are unwilling to sell your stock, then do not sell covered calls against it. But, unless you are a company founder or something similar, there is no stock that you should not be willing to sell. The key is to do enough research so that you have several alternative stocks that you want to buy if your call options are exercised.

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