Writing options fall into two categories. Covered and Uncovered, either way the position is considered short. The option can be covered by a position in the underlying security or by another option. The uncovered option writer assumes a great deal of risk generally for small profit.
Covered with a position in the underlying.
Covered Call writing or "Buy Writes" One owns the underlying security to make delivery if the calls are assigned. The options are either In-the-Money, (ITM) the strike is below the current market price of the underlying, At-the-Money, (ATM) the underlying price and the exercise price are the same, or Out-of-the-Money, (OTM) the strike is above the price of the underlying. The ITM option offer the greatest amount of downside protection but the maximum profit potential is the time premium. ATM calls offer good downside but again only time premium as profit. OTM options allow greater upside potential on the stock but provide smaller premiums and thus a smaller hedge on the stock. There is no right or wrong in the selection of strike price. Personally, I will tend to write OTM calls during bullish market conditions. The premiums are better and the stock has a better chance of being called. The average returns are around 16% to 18% annualized. In neutral to bear markets I'll write calls ITM, and be happy with 10% to 12% returns. Writing covered call also makes for a good exit strategy or a method to augment dividends. Example: One of the few times I didn't sell the option at the same time. I bought @ 7.62 with a price target of $20. 14 months later the stock was @ 19 and change, so I sold the 20 calls. In effect I was paid another 2 points to sell the stock @ 20 where I wanted to in the first place. I have also used selling call options to augment dividend income. The stock is a large cap boring, but good dividend paying. I sell far OTM options about every 4 months. The stock dividend alone is about 4.20% but with the option income the annualized yield is increased to 8% to 10%.
Covered with another Option. The option buyer has the enemy of time, as each day passes the time premium in the option will decay. For the option writer time is now your ally. The only thing I know of that is guaranteed in the market is the passage of time. Credit spreads make great use of time decay. Credit Call spreads are neutral to bearish, credit Put spreads are neutral to bullish. Example: The stock is @ 64.91 and over the last 6 months has struggled above 70 unable to crack 75. Heading into the summer doldrums. Write the June 75 calls @ 3.30 and buy the June 80s for 2.10. The result is a credit of $1.20. The spread is 5 points. If one was the put on the position for 10 contracts on each side the capital requirement would be $5,000 less the credit of $1,200. If as anticipated the stock does nothing and both options expire worthless, one has a profit of $1,200 from a $3,800 investment, or 31.5% from now till June 19th. The breakeven point would be 76.20, maximum loss is the $3,800. Selling the 80s and buy the 85s put the trader even further away and requires the stock to have an even bigger rally to cause trouble. The tradeoff is the credit is .75 so the loss the capital required is higher and the profit percent is lower. The credit put spread is basically the same with stocks that are showing support at some level.