We’re enjoying a bull stock market market so far this year, as stocks build on their robust gains of 2023. But a disproportionate share of this upward trajectory is being driven by mega-cap tech stocks. What’s more, inflation fears haven’t been vanquished, the Federal Reserve remains a wild card, geopolitical risks continue unabated, and bond yields have been rising again.

Is the bull market of 2024 a bubble in search of a pin? My colleague Jim Fink tells you that it doesn’t matter. Jim makes money in good times and bad, in bull and bear markets.

For today’s column, I decided to step back from the daily ups-and-downs of the markets to pick the brain of Jim Fink [pictured]. He’s chief investment strategist of the premium trading services Options for Income, Velocity Trader, Jim Fink’s Inner Circle, and Seasonal Stock Alert.

When Jim Fink speaks, the rest of his colleagues at Investing Daily listen. And with good reason.

Jim holds a bachelor’s degree from Yale University, a master’s degree from Harvard’s Kennedy School of Government, a law degree from Columbia University, and an MBA from the University of Virginia’s Darden School of Business. For good measure, Jim has been a member of the Illinois and D.C. legal bars. My questions are in bold.

I’m skeptical of investment strategies that try to out-guess market professionals or rely on a “greater fool” to pay more for an asset of questionable value. As for options, I’ve known many investors who use them successfully to leverage their gains, protect against potential losses and increase income. I know many more who got in over their heads and lost their shirts, despite being convinced they weren’t taking much if any risk. Can you explain options trading and how using it can help our approach to the market?

John, let me start by thanking you for inviting me to discuss options with you and your Mind Over Markets readers.

Options are wonderful and flexible tools that can be used by stock investors to reduce risk and enhance returns. I think they’ve gotten a bad rap over the years because they’ve been used improperly by “get rich quick” traders rather than long-term investors. As with any tool, options can be abused. But the problem is not with the options tool itself, but in its application.

And I’m here to explain how options can be used in a conservative and income-producing manner that is investor-friendly and perfectly in-line with the investment philosophy of your subscribers.

Stock options are derivatives. They derive their value from the underlying value of a stock. They represent the right to buy or sell 100 shares of that underlying stock at a certain price on or before a predetermined date.

There are two types of options, calls and puts. There are two sides to every option transaction: the party buying the option, who has a long position, and the party selling (also called “writing”) the option, who has a short position. Each side comes with its own risk-reward profile and its own strategies.

A call is the option to buy the underlying stock at a predetermined price (strike price) by a predetermined date (expiration, which is usually the Saturday after the third Friday of a month). The expiration date chosen can be as soon as next month or as distant as two and a half years away from now. If the call buyer decides to exercise the call option, the call writer is obliged to sell his shares to the call buyer at the strike price.

A put, in contrast, is the option to sell the underlying stock at a predetermined strike price until the expiration date. If the put buyer decides to exercise the put option, the put writer is obliged to buy the stock from the put buyer at the strike price.

A call buyer seeks to make a profit when the price of the underlying shares rises. The call option’s price will normally rise as the shares do, because the right to buy stock at a constant strike price becomes more valuable if the stock is priced higher. Similarly, a put buyer profits when the underlying stock price falls. A put increases in value as the underlying stock decreases in value, because the right to sell stock at a constant strike price becomes more valuable if the stock is priced lower.

Buying options can be risky because they have a limited lifespan. If the stock doesn’t move in the anticipated direction by the expiration date, the option will lose money. The amount of loss depends on the relation of the option’s strike price to the underlying stock price, but the loss could potentially equal the entire amount of one’s initial investment. The reverse is true, too; options are leveraged investments, so the potential percentage gain from buying an option is much larger than from buying a stock.

But for conservative investors, I don’t recommend purchasing options. Rather, I recommend selling options to complement, not replace, their buy-and-hold stock portfolio. All of the risks associated with buying options are eliminated, and reversed, for the option seller. Option sellers actually benefit if the option expires worthless. They get paid up front in cash and earn extra income. This extra income actually reduces the risk of stock ownership. Imagine that: Options can actually reduce risk.

As I stated, my investment strategy includes paring back on stocks that have risen substantially and buying stocks at cheap prices during fear-induced general market selloffs. How can options achieve both of these investment objectives?

For paring back on overvalued stock positions, I recommend selling covered calls. The term “covered” means that you only sell the number of calls that equal the number of shares of stock you already own (divided by 100, since each call option consists of 100 shares of stock).

Let’s say that you would want to sell 200 shares of your stock holdings at $50 per share. Rather than place a limit order to sell at $50, you could sell two call options with a strike price of $50 for hypothetically $2 per share. If the stock closes above $50 at expiration, the call options would be exercised by the call buyer and you would be required to sell 200 shares of stock at the $50 strike price.

The benefit of selling your stock through option exercise rather than a limit sell order is that you get paid an additional $2 per share in income on top of the $50 sale price, making your net sales price $52.

For buying stock cheap during fear-induced market selloffs, I recommend selling puts. For example, let’s say you’d love to buy a stock if it fell in price to $30. Rather than place a limit order to buy 200 shares at $30, you could sell two put options with a strike price of $30 for, hypothetically, $2 per share. If the stock closes below $30 at expiration, the put option would be exercised by the put buyer and you’d be required to buy 200 shares of stock at the $30 strike price.

The benefit of buying your stock through option exercise rather than a limit buy order is that you get paid an additional $2 per share in income, making your net purchase price only $28.

The great thing about these two option-selling strategies is that you can rest easy without worrying about options expiring worthless. You aren’t speculating on stock movement within a limited time period. Regardless of how the underlying stock price moves, selling options reduces the cost and downside risk of your stock ownership.

The only risk, if you can call it that, is you will make less money than straight stock ownership if the stock price skyrockets upward. But missing out on a speculative upside gain is much less painful than losing money.

To many conservative investors, who are more concerned with capital preservation and income, these two options strategies are comforting.

Editor’s Note: My interview with Jim Fink only scratches the surface of his investment acumen. In fact, 12 simple words…taught to you by Jim…have the power to hand you $1,463 every Thursday. Just like an extra paycheck! This simple market move takes as little as seven minutes to put into action.

Jim’s investment methods have enabled him to take his life’s savings of $50,000, turn the amount into $5 million, and retire early at age 37.

Jim Fink has been sharing his trading secrets for over a decade. While the market tanked several times over the last few years, he hasn’t closed out a single losing trade. Click here to learn more.

John Persinos is the editorial director of Investing Daily. You can reach John at: mailbag@investingdaily.com

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