In fact, we can earn a lot of money by trading and specifically trading options. But there are some key factors that have to be present to achieve that goal. But for the majority of us, as retail traders, we should accept the fact that to make money out of trading options is to earn a side income out of part of our individual wealth.
Hence, trading options for income may be the first step towards building a sizable portfolio that might eventually become sizeable enough in order to get an absolute value that would be sound. For a portfolio of $500k to achieve a 2% monthly (fairly accessible without high-risk options strategies) will give 10k per month… but, a 5K account will only produce $100… it depends on investment account size!
Most traders associate investment success with a high success rate of winning trades as well as large returns on a set of individual trades.
Besides several stock and options trading websites claim high return / success, the most fundamental theory behind investing continue to be the relationship between risk and reward. Period! While a trader could successfully invest in one single and have a huge success with very large return, committing a significant portion of everyone funds to a single security or strategy exposes anyone account not just to high rewards, but also to a significant risk of losing all your money. Trading options for income is not a get-rich-quick scheme. That is more “gambling”. By contrast, it is a systematic implementation of a set of strategies intended to yield consistent results over time.
A trader portfolio’s performance is successful when it would provide additional income while progressively build a growing amount of capital that will continue to deliver bigger absolute returns over time.
As stated above, the amount of capital you are willing to invest to trade options for income is a numbers game. Experienced traders have set their goals to achieve 2% – 3% monthly returns on their portfolios without incurring significant risks. This means that to produce $5,000 per month, you need to have around $200,000 to $250,000 available to invest.
Another fact that impacts is the time you are willing to commit to trading. Most people who want to start trading also have a day job that demands a significant portion of their time. Which is ok, but trading options, like any other activity, requires time (not only dedicated to trading itself), but also to study, research and practice. I took about 6 years to study, practicing, trading, losing until reaching a consistent level. Discipline, studying and managing positions risk was a game-changer for me!
To achieve success on trading, like in any other profession, will be related to the time invested in learning and implementing trading strategies until achieved an expertise level that will produce consistent returns. Also, I can tell you, that a mentorship helped me a lot! It made me learn faster and alerting me to some dangerous positions I was taken as well as other kinds of adjustments made possible by the flexibility of options. Trading with someone will also boost your knowledge as it could deliver different perspectives. If possible for you, better to not trade alone (especially if you do not achieve an expertise level on options trading). There’s much more on options trading in terms of complexity than trading stocks.
Some simple strategies
Selling a Put is an easy way to generate income. Doing this also allows you to buy a stock at a price lower than the current traded price. A put option gives the holder the right, but not the obligation, to sell the stock at a certain strike price at or before the option expiry. Traders selling a Put must be willing to take ownership of 100 shares of the stock at the strikes price you sold the option. There are other factors you could enter into the equation when doing this like the level of IV (Implied Volatility). For example, in beaten-down stocks where the IV is high could deliver opportunities to capture more premium. If every month you sell a set of Puts in several stocks you could spread the risk and have a nice income. The strike at you sell is also impacting the level of premium collected and the probability of profit.
A covered call is an option trading strategy that consists of selling call options on stocks you currently own. A call option gives the holder the right, but not the obligation, to buy a stock at a certain strike price at the expiration date of the option. Covered calls are great if you have a neutral to slightly bullish view on the stock.
By selling a call on a stock you own, the trader earns a premium. If the stock’s price remains the same or it drops, the option will expire worthlessly and the trader keeps the stock and the premium collected. On the contrary, if the security increases in price, the buyer of the option may exercise the option and the seller will have to sell the stock at the strike price.
Putting both strategies to work
Suppose you want to buy AAPL shares. It closed on Friday at 353 after a 3% drop, so IV is a bit inflated versus a normal state. Monday, at market open, you have 2 ways to buy AAPL stock:
1. The stock trader: simply buys 100 shares with a total investment of $35300 and hope it will move up in the future to sell them for profit. Or l lose if he sells at a lower price.
2. The options trader:
a. Sell one Put at 340 for 6.30 with Expiry on 17 Jul (18 DTE) for an approximate $6000 margin commitment and a credit received of $630;
i. If at the expiry date, AAPL closes above 340, the Put expire worthless and the option trader keeps all the premium collected ($630);
ii. If it closes below, the option is exercised and the trader bought the 100 shares at $340 for a total investment of $34000
iii. Selling Puts can be done continuously (every month or week) and the credit continuously be cashed in until option is exercised;
b. At a given moment, when the Put is exercised, the trader owns the shares. He can now start selling Calls against them, collecting premium until, again, they are exercised
i. If at Expiry, the stock continues to fall, credit from sold Calls is being cashed in
ii. In a moment where AAPL shares will close above the strike price of the sold Calls the shares will be exercised and are sold at that strike.
What you could see above is the flexibility of options can give versus simply buying or selling stock. In the example above, you cashed in credits from Put selling. And, at exercise date, you bought the 100 shares at lower price than initially!
When you understand the power of options, you will never want to go back to trade stocks! And that example is a pretty basic usage of options!