Trading options doesn’t have to be risky. In fact, options can be a great risk mitigation strategy for your portfolio and can help increase your income. Here is how to trade options for income.
Trading Options for Income – 4 Proven Strategies that Work
My friend, Gavin McMaster, is a day trader and options trading blogger for his site OptionsTradingIQ.com. He’s very sophisticated with trading options and trades full-time. I was very eager to have Gavin join me on the Financial Wolves blog to help you understand how you can boost your income trading options.
With that being said, take it away Gavin….
Trading is often associated with glamourous lifestyles, mansions, private jets, and excessive partying. This image of a trader might have been promoted by Hollywood movies that tend to mislead viewers into believing that trading is an easy way to get rich quick.
Yes, you can get rich by trading and yes, you can make tons of money by specifically trading options, but the fact is that certain elements have to be in place to achieve that goal.
In contrast, most humans that intend to make money out of trading options just want to earn a side income from their investment funds.
That said, trading options for income may be the first step towards building a sizable portfolio that might eventually become the cornerstone of your wealth if you play your cards right.
Keep reading to find out how you can trade options for income through 4 different time-tested strategies.
The Truth About Trading Options for Income
Most people associate investment success with nailing large returns on a set of individual trades.
Stock tips and ‘hot’ investments are usually seen as the express tickets to riches, even though one of the most fundamental theories behind investing is the relationship between risk and reward.
While you could identify and successfully invest in one single stock or option and make a killing, committing a significant portion of your funds to a single security exposes you not just to high rewards, but also to a significant risk of losing all your money.
The truth is that trading options for income is not a get-rich-quick scheme. Instead, it is a systematic implementation of a set of strategies intended to yield consistent results over time.
Your portfolio’s performance may not land the headlines of your local newspaper, but it should definitely provide additional income while progressively building a sizable amount of capital that might open the doors to more attractive investment opportunities.
Setting Your Expectations with Options Trading
How much can you earn by trading options for income? Can you achieve a six-figure income through it? Is it possible to make a living out of trading options?
The answer to all of these questions is YES. But achieving that ‘yes’ is intimately related to some of the following elements:
- The amount of capital you are willing to invest: Trading options for income is mostly a numbers game.
Most experienced traders aim to achieve 1% – 2% monthly returns on their portfolios without incurring significant risks.
This means that to produce $5,000 per month, you need to have around $250,000 to $500,000 available for your trading operation.
Most people don’t have that kind of money lying around, which means that you have to build a portfolio progressively by reinvesting your gains and wisely allocating your money.
- 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.
Trading options for income, like any other activity you wish to pursue, requires time, discipline, some degree of study, and practice.
Your trading success is directly related to the time you invest in learning and implementing your trading strategies until you develop the kind of expertise that will produce consistent returns.
- The right mindset: There are a lot of behavioral traps involved in trading that may drive you to make irrational decisions or expose you to unnecessary risks. Traders have to develop the right mindset to make sure their prejudices and insecurities don’t act against their trading goals.
Now that you know what to expect from trading options, here are some strategies you can start learning and practicing to build up your own money-making machine.
You can start trading options for completely free with the Robinhood app. No commissions no strings attached.
Best Strategies for Trading Options for Income
Let’s dive into some straightforward options trading strategies that will increase your income yield.
Strategy #1: Selling Puts
If you have already set your mind on investing in a certain security, planning that its value will increase over time, selling a put is an easy way to generate income.
Doing this also allows you to buy the 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 are put must be willing to take ownership of 100 shares of the stock at the strikes price.
Let’s say you want to buy Apple stock (AAPL), currently trading at $315. You could sell a put that expires in 1 month at a strike price of $315.
Selling a $315 strike put might generate $12 or more per each option you write. Each option is usually comprised of 100 shares, which means you’ll earn $1,200 as a premium for writing the put.
If the price of AAPL ends up being the same or higher (remember you are bullish on the stock), the option will expire worthless and you’ll keep the $1,200 you previously earned as a premium from writing the put.
On the other hand, if the stock decreases in value, even though you may lose money from having to buy the stock at a higher price, a portion of your losses will be offset by the premium earned, and you’ll end up owning the stock as a result, which was something you intended to do in the first place.
Here is a snapshot of your returns under the above mentioned scenario.
Once you own the stock, you can collect the dividends and sell covered calls, which leads us to strategy number 2.
Start selling put options with Robinhood with no commissions. You’ll even get a free share of stock for signing up.
If you can’t access Robinhood and want something more comprehensive, check out these top Robinhood alternatives to consider.
See Related: Best Dividend Income Trackers to Use
Strategy #2: Covered Calls
A covered call is an option trading strategy that consists of selling or ‘writing’ 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 writing a call on the underlying security, the writer earns a premium. If the stock’s price remains the same or it drops, the option will expire worthless and the writer gets to keep the underlying security AND the premium earned.
On the other hand, if the security increases in price, the buyer of the option may exercise the option and the writer will have to sell the stock at the strike price.
Since the writer is predicting that there will be little to no change in the price of the underlying security, this strategy should result in a benefit equal or similar to the premium collected from writing the call option.
Let’s say you currently own 300 shares of AT&T Inc. (T), currently priced at $39.
If you expect the stock to remain fairly flat over the next 3 months, you can write 3 call options on these shares.
Using a strike price of $40 allows you to collect around $0.73 in premium per share so $219 in total before commission.
If the price of AT&T’s stock remains below $40 by the expiration date, you’ll end up generating an extra $219 in income from your shares in addition to any dividends you received during that time.
If the stock increases over $40, you’ll have to sell the stock at $40, losing any further capital gains in the process.
If you were already planning to sell the underlying security, a covered call is a good play to generate some extra income from the stock.
Under the scenario outlined above, here is the profit scenarios for ATT.
See Related: YieldStreet Review – Invest in Alternative Assets
Strategy #3: Vertical Spreads
Vertical spreads are a more complex way to trade options for income compared to the previous two strategies, as they require a set of interrelated transactions that need to be properly understood.
This strategy is a limited-risk, limited-reward approach, since it puts a cap on the potential losses the trader may face, while also putting a maximum limit on the gains.
There are essentially two types of vertical spreads, depending on the trader’s view on the underlying security’s future performance, these are bull spreads and bear spreads.
Additionally, they are subdivided into bull call and put spreads, and bear call and put spreads.
Each strategy consists of buying and selling options with different strike prices that expire on the same date.
Depending on the trader’s expectations on the behavior of the underlying security, the trader may choose among these four strategies to profit from the directional movements of the security’s price.
Selling vertical spreads is a great way to generate income while also allowing a small margin for error if the trader’s direction view turns out to be wrong.
See Related: How to Invest a Small Amount of Money
Strategy #4: Iron Condors
An iron condor strategy involves trading four different options contracts that have different strike prices but the same expiration dates.
The strategy involves selling an out of the money call and put and then buying calls and puts further away from the current stock price.
Because the calls and puts that are purchased are further away from the money that the calls and puts being sold, the traders receives a net premium for placing the trade.
Iron condors are the most popular income trade for option traders.
Trading an iron condor involves combing a bull put spread and a bear call spread.
Even though this strategy is mainly used when the trader’s sentiment towards the future performance of the underlying security is neutral, the trade can actually profit in a number of ways.
Stocks can move one of fie ways during the life of an iron condor:
- Up a lot
- Up a little
- Down a little
- Down a lot
Stock investors can only make money in the first two scenarios.
Iron condor traders will make money in the middle three scenarios so they are a fantastic addition to a portfolio that can help investors outperform during flat years for the general market.
Losses are capped by the call and put options bought, while profits are also capped, with the maximum profit being realized if the security’s price remains neutral and a net premium is collected from the options sold minus the smaller premiums paid on the options bought.
See Related: How to Invest in a Company
Conclusion on Trading Options for Income
Trading options for income is highly rewarding for traders that know what they are doing. It’s important to have a solid grasp of option fundamentals before diving into this style of trading.
There’s no guarantee that you’ll be able to generate steady returns within the first few months, but as time passes and you learn how to identify potential targets for these strategies you will move one step closer to produce a reliable source of income from trading options.
Start trading options with Robinhood with no commissions. You’ll even get a free share of stock for signing up.
Do you know how to trade options for income? Let us know if you have any questions.
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Gavin McMaster has a Masters in Applied Finance and Investment. He specializes in income trading using options, is very conservative in his style and believes patience in waiting for the best setups is the key to successful trading. Gavin has written 8 books on options trading and you can find more from him at www.optionstradingiq.com