Founded in by brothers Tom and David Gardner, The Motley Fool helps millions of people attain financial freedom through our website, podcasts, books, newspaper column, radio show, and premium investing services. Many investors approach options with skepticism and caution — some simply refuse to even consider them. That's not entirely unreasonable — you don't need to use options in order to be a successful investor. Even I believed for a long time that options were not a Foolish way to invest.

But as I began to learn more about options, I discovered that they are excellent tools for generating income, protecting profits, hedging, and, ultimately, earning outsized gains. Eight years ago, I took the plunge and started using options alongside my stock portfolio. I've found that options can generate returns in flat markets, cushion the blow of down markets, and be outstanding performers in decent markets.

Whatever your investment goals, options can be a powerful addition to your portfolio. Option strategies are an important element of Motley Fool Pro , where we use them to hedge, to short, to produce income, and to obtain better buy and sell prices on our stocks. What's important to know is that we trade options as investors , not as speculators.

Any option trade should always be taken based on thorough analysis of the underlying stock and its value. That way, the option is simply a way to leverage what you know about a stock. Stock options formally debuted on the Chicago Board Options Exchange in , although option contracts the right to buy or sell something in the future have been around for thousands of years.

Applied to stocks, an option gives the option holder the right, but not the obligation, to buy or sell an underlying stock at a set price the strike price by a set date the expiration date.

The option contract allows you to profit if a stock moves in your favor before the contract expires.

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Not all stocks have options — only those with enough interest and volume. There are only two types of options: A call appreciates when the underlying stock rises, so you buy a call if you are bullish on that company. A put appreciates when a stock declines. You buy a put if you believe a stock will fall or to hedge a stock that you already own. One way to remember this is: Next, let's walk through the most common options trades we make in Pro: When you believe a stock will rise significantly over time and you want to leverage your returns or minimize capital at risk.

To get paid while waiting for a lower share price your desired buy price on a stock you would be happy to buy. Investors often buy call options rather than buying a stock outright to obtain leverage and potentially increase returns several-fold. Call options work as "controlled" leverage, enhancing your possible returns while limiting your potential losses to only what you invest which is usually a much smaller amount than a stock purchase would be. Because each option contract represents shares of stock, an investor can control — and benefit from — many shares of stock without putting a lot of capital at risk.

When you make the right, er, call, you'll enjoy higher returns than you would have if you had used that money to buy the actual shares. Let's look at an example. You believe the shares will rebound in the coming months or year.

If your stock starts to rise again, your options will increase in value, too. If you had simply bought the stock, you'd only be up Of course, there is a flip side. Suppose your stock continues its decline to the abyss. At Pro , we typically buy longer-term call options on well-valued stocks that we believe will reward us — and you!

It's a way for us to take more meaningful positions in stocks we believe in, without risking mounds of capital. This is useful if you're lacking capital or just don't feel like risking it all in a stock. As with any investment, you should only invest what you can afford to lose, since a stock can easily work against you in a set amount of time and make your call worthless. Where real opportunity is lost is when your timing is wrong.

Your options might expire before the stock rebounds, causing you to lose your option money and miss the stock's eventual rebound. Thus, we aim to buy longer-term calls in positions in which we have high confidence and near-term catalysts. We buy put options when we believe that the underlying stock will decline in value. Buying puts is an excellent tool for betting against highly priced or troubled stocks, or even entire sectors!

With put buying, your risk is again limited to the amount that you invest in stark comparison to traditional short selling, where your potential losses are unlimited.

Aside from betting against a position with puts, we may also buy puts to protect an important position in our portfolio, one that we don't want to sell yet for any number of reasons. When a stock being protected — or hedged — in this way declines for a while, the puts will increase in value, smoothing out returns. Pro will buy puts on stocks that we believe are due to decline over the coming months or even years. We may also use puts to hedge long positions that we own, or to short sectors and indexes in a small portion of our portfolio.

We'll almost always buy puts rather than short something outright to limit our risk — and yours. Now our overview moves from the act of buying options to, instead , selling them to others. Any qualified investor can "sell to open" an option contract. When you do so, you don't pay the premium; instead, as the contract writer, you get paid instead. All cash generated from your option selling is paid immediately and is yours to keep. The call options that we write or sell in Pro are covered calls.

Writing covered calls is one of the most conservative options strategies available. In fact, most retirement accounts allow you to write covered calls. They're generally used to generate income on stock positions while waiting for a higher share price at which to sell the stock. Here's an example of a covered call. Suppose you own 1, shares of a stable, blue chip stock.

You could then write more calls if you wanted to. Your actual proceeds on the sale would include the option premium you were paid. So you sold your shares at the price you wanted to and received some extra cash for doing so. When you write covered calls, you must be prepared to give up your shares at the strike price. This is the biggest downside to covered calls -- lost potential if a stock price rises.

The other risk is that a stock may fall sharply after hovering around your desired sell price for a while, forcing you to wait longer for your sell price. Even though covered calls are low risk, we'll still use them only on stocks we know well. We may even set up some covered-call only positions — buying a stock just to write calls on it.

You won't actually need to use margin — which entails high risk — but you must be margin-approved, have ample buying power cash, in our margin-free strategy , and have full options permission from your broker.

Selling puts — also referred to as selling naked puts -- is a favorite strategy of mine to seed a portfolio. There may be plenty of stocks that we'd like to buy at the start, but we'd prefer to snag them at lower prices. Put options are an excellent way to potentially buy a stock at your desired, lower share price and get paid an option premium while waiting for that price, whether it arrives or not.

Let's turn to an example: A few things could happen here. We didn't get to buy the stock at the price we wanted, but at least we made money on the options we sold. So we won't own the shares and we'll have missed our buy price and the stock's rebound -- but we did get paid the premium, at least, and can try again.

But we own the stock now and can hope it rebounds. In Pro , we will most often sell puts when a stock we follow closely and want to own is, alas, above our desired buy price. We'll sell puts on it at lower strike prices, prices that we believe are great levels at which to buy.

Either we'll eventually get to buy the stock at our desired price via the puts, or we'll keep writing puts if the situation merits it. We may also sell puts when a stock we already hold a partial position in is above the price where we'd like to buy more. We'll write puts as we wait to average in at lower prices.

This is a great tool for allocation and averaging into a position. Writing puts on stocks you know well and want to own at lower prices can be an excellent tool for income and for securing lower buy prices, but you must be prepared to buy the stock should it fall below your strike price.

At all times, you must maintain the cash or margin for us it's always cash and we recommend you follow that rule, too to buy shares if they are put to you. It's important that you only write puts on stocks that you understand well and will be happy and ready to buy at the prices you're targeting. The risks of writing puts include the fact that the stock could soar away without you.

In many cases, it's better to just buy a great stock once you've found it. The other risk, of course, is that a stock falls sharply and you're stuck owning it. The biggest risk with selling puts, as with all options, is when investors use rely on margin instead of cash.

That can quickly wipe out a portfolio.

Options: The Basics II -- The Motley Fool

The right, but not obligation, to buy a stock at a set price the strike price ; calls appreciate as the stock rises remember: The right, but not obligation, to sell a stock at a set price the strike price ; puts appreciate as the stock falls remember: The obligation to sell a stock at the strike price; must hold the stock in the account.

This is called a "covered" position. The obligation to buy a stock at the strike price; must have the buying power at the ready preferably in cash in case the stock declines.

If the stock rises, is ready to sell her existing shares at the strike price, keeping the premium paid for writing the option. If the stock falls, is ready to buy it at the strike price, keeping the premium received for writing the option. Applying for options trading permission with your broker involves filling out a form that they'll give you when you ask.

Simply say, "I'd like to apply for full options trading permission, please. It can take a week or longer to get approved.

If you plan to follow along with our options trades, you'll want to apply for full permission right away. The advantage of buying an option contract or two is that you can "control" many shares of the underlying stock for, typically, just a few hundred dollars. If the stock rises, you'll earn strong higher returns on your money.

To sell — or write — options, you should have a higher account balance and you'll need a margin account as well. If you're not ready or able to sell puts yet, that's perfectly fine. It's probably the strategy you should consider last if you're new to options. We suggest starting with the more practical and less expensive strategies of buying calls, buying puts, or writing covered calls.

As your account grows over time, you can try out more involved options strategies.

Options: A Foolish Introduction -- The Motley Fool

When writing any options, the brokerage terminology usually used to start the position is "sell to open. Be sure to review your cash and margin buying power before writing a put option. Meanwhile, buying options is not unlike buying stocks. You can buy options with cash or partly on margin, but margin is certainly not recommended. We will only use cash to buy options in Pro. Our Options overview is just that: Options are volatile, often moving with much more severity than the underlying stock, and they can present great risk to uncertain investors, as well as great reward to those with steady strategies who have done their research on the underlying stocks — as, of course, we always do at Pro.

We use options to capitalize on our business-based, valuation-centric investment approach and enhance our returns. In your own portfolio, you can use options alongside us to improve your performance and expand your possibilities. If you are interested in receiving more information from The Motley Fool about investing in options, please click here.

And be sure to stay tuned for more options content from the Fool in the days and weeks to come.

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Personal Finance Credit Cards Best Credit Cards of Best Credit Card Sign-Up Bonuses Best Balance-Transfer Credit Cards Best Travel Credit Cards Best Cash-Back Credit Cards Best No-Annual-Fee Credit Cards Best Small Business Credit Cards. From Motley Fool Pro: Options Get a peek at how the Pro team uses options in their real-money portfolio service.

Strategy Why Buy Calls When you believe a stock will rise significantly over time and you want to leverage your returns or minimize capital at risk Buy Puts To "short" a position, or to hedge or protect a current long holding Sell Covered Calls sell to open To earn income on shares you already own while waiting for your desired sell price Sell Puts sell to open To get paid while waiting for a lower share price your desired buy price on a stock you would be happy to buy.

Call Option Put Option Option buyer The right, but not obligation, to buy a stock at a set price the strike price ; calls appreciate as the stock rises remember: The obligation to buy a stock at the strike price; must have the buying power at the ready preferably in cash in case the stock declines Option buyer Believes the underlying stock will rise Believes the underlying stock will fall Option writer or seller If the stock rises, is ready to sell her existing shares at the strike price, keeping the premium paid for writing the option If the stock falls, is ready to buy it at the strike price, keeping the premium received for writing the option.

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