Ep 118: Top 5 Option Strategies for Monthly Income

January 12th, 2017

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Today we're going to cover top-five option strategies for a monthly income.

I want to cover some of these monthly option strategies that you can use for monthly income. Those are the common ones. There are many more option strategies than the ones that we will be covering here. But this will give you a big picture overview if you're getting started with option trading.

It will give you a big picture overview of how money is made from option strategies. Also, I'll show you some of the common ones. We're not going to go in detail about managing or adjusting any of them.

Disclaimer

Before we get started keep in mind, all these are for illustrative purposes. I think everybody should understand that by now especially if you're watching stock market education videos or finance videos.

Everybody's risk tolerance is different, and you might be reading this in the future. Always contact your financial advisor before making any trades because you could incur some significant losses if you don't know what you're doing.

Put the time and effort to learn. None of the things here are recommendations to buy or sell or trade any options or stocks.

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Take a look at Traders Fly website and click section Live Classes. If you're a newsletter member, then you can get a free webinar.

I started doing these and if you want a live session then sign up for the newsletter which is usually at the bottom of the page.

Then you'll get access to when the webinars are for some of these things. We do a few free webinars for the newsletter subscribers. If you're interested in those and they are usually more interactive or specific to the stocks or lessons you want to cover. They can change depending on your needs.

Top 5 Option Strategies

I'm going to use the thinkorswim platform right here which is by TD Ameritrade.

Strategy #1 - Standard Selling Covered Calls

One of the first strategies that I want to share with you is going to be a standard selling covered calls.

Take a look at Amazon. You need 100 shares to do this strategy. You can do it on Amazon, Netflix or ETF that you have that also trades options.

The important thing is that you need 100 shares because one option contract is 100 shares. That's why we need at least 100 shares. I'm going to buy this to show you an example of how this works.

You can see the cost here is $87,000 in the margin. Now if we go into Netflix, you can see if it goes up to ten points I make about $1,000. The reason is that it's around the $130 price level.

Your profit and loss are left and down there is the price of the stocks. As things continue to move up, you're more profitable because here is our zero-line. As things continue to move down, you lose money.

This all is based on having stock, and you have stock. The first option trade or strategy that you can use to making money is to sell upside calls.

It's called a covered call. Take a look at Netflix. We bought the stock at around $130. If I think it's going to sell-off and go lower, I could sell a call contract at the $140. This is resistance, and there're some problem spots.

That's what it allows me to do. Usually, a call is for the upside. If you buy a call, you're looking for a stock to go up. However, when you sell the call, it's the opposite effect. You're taking the opposite side of the trade.

I could say 140 is right there. I'm getting about $4.05, and I'm 36 days out. What I do is I sell, and it's off the screen a single. And I can analyze the trade. You can see how my graph changed. It looks a little funky, but basically, the green line is the expiration line. The white line is the current line today.

We used to have a straight line to the upside. With time these contracts that we're selling expire. That's what we're doing. We're selling insurance on the stock. Here as I continue to move the date you can see I'm making money through the Theta every day about $10.

And that will continue to increase. You can see as I'm moving the date my profit and loss that's tied to this continues to rise and grow. You're allowing these options to decay and expire through selling them.

The downside with this is if the stock continues to 160 you are forced to sell your shares at 140. That's because here's our initial position. If we put on this trade and we sell the 140, we're able to get the premium of 4.05.

But if it goes beyond the 140, we lose out. If it goes to 150, we are forced to sell it at 140. In that case, we still make the profit from the stock from 130 to 140. But at 140 anything beyond that, you don't get the additional profit.

What happens is they take away your stock. You're going to make a profit from your stock, but you also get to collect the premium of that 140 call.

That's why you need to be able to own that stock. If you do it without owning the stock, the call is going to look like this. In that case, you can see if it continues to head higher you lose money.

If the stock heads to 250, you lose $10,000. That's why you need to own the stock to do this strategy. But you can see because this one on its own allows me for upside selling the call is a downside. But I'm at the 140 I'm further beyond what I'm buying it at.

Putting these two together (the stock plus the call) allows me to still get some upside room. That way if the stock stands still I always at least collect some money. If it goes up a little, I make money. If it goes down some I still at least make 4.05 on the call which multiple times 100 you can see I'm making $405.

I'm still making some money even if it goes down rather than losing on the stock value. But if it goes up past 140, I always get to keep my $405.

In that case, I sell the stock $10 away from where it is now. That's the first strategy, and you can do this month after month. Some people have a couple of thousand shares of stock, and then they may sell only three or four contracts on those positions.

That way they're always still having exposure. But they do it month after month and continue to collect the premium. This is one strategy that you can do consistently and make money every single month. That's selling a covered call strategy.

Strategy #2 - Naked Strategy

The next strategy I want to share with you is a naked strategy. This one is a little more dangerous. However, you'll see the advantage to it here.

We'll use Amazon to go into a naked strategy. Let's say this stock got away from you a little bit. The stock broke out, and you missed a move.

This strategy is a good strategy if you want to buy the stock. If you're going to own the stock and you have enough money to own the stock at a lower level.

I'm going to show you. The stock is at 803 right now, but you missed a move at 750, and you don't mind buying it at 740.

In this scenario, I can go to Amazon. This is 36 days out. I could say I'm going to go into about 740 or 735.

What I'll do is I'll sell a single and analyze the trade, and this is a put this time. If you buy a put, you want the stock to go down. But since we're selling a put, we want the stock, in theory, to go up.

This is also putting me in a position for unlimited losses until 0. That means people can put that stock to me at 735. If the stock goes to 700 since I'm saying already I don't mind owning the stock at 735 - this is what this is going to do. But it allows you to buy it at a lower level.

Here's how this works. If the stock stand still you make money because you're selling the option. If the stock goes up, you make money.

If it goes down, you start to lose money on this option premium and value. But in the end, you still get to capitalize and make this $780.

The big downside for this is if this gets to 720 you're going to be forced to own the stock at that 735 level. At 735 you're going to be forced to buy 100 shares. The reason is that we have one contract for this stock.

If the stock stand still you make money. The stock goes up, and you make money. The stock goes down a little bit, and you can still keep the profits of $780 from this - so you still make money.

The problem is at expiration if this gets in the money. Anything below that $730 range you will be put 100 shares of that stock at 735. That the case even if that stock is at 600 or 200.

We're saying that we don't mind owning the stock at 735-740. That's the right price level looking at this chart. And if you say that when you sell a naked put on this - you're going to be forced to buy that if it goes below that strike price.

If it doesn't, you get to keep the money. And you can do this month after month. And if the stock starts getting to 860, you can raise this to 750 and so forth.

You can do this month after month until you get the stock. It's another strategy that people do for nibbling on stocks or trying to bottom fish on stocks. It allows you to capitalize at lower prices. But still, you get to collect the premium if it goes against you. That's another option strategy for monthly income.

Strategy #3 - Vertical Spread

We'll do it also on Amazon. We're going to sell a vertical. First I'm going to sell a single. We'll start on the put side.

It's very similar to what we had, and then I'll buy one for protection further out. In this strategy, you don't need to own the stock. You don't have to deal with anything with the stock. You will not get assigned the stock because this is why you're buying a single one later down in the strike prices.

If I buy a put remember it's for the upside. I'm buying it though further out. That's what the difference in the strike price is, and this creates a picture profile like this.

The way this works is stock stands still - you make money. You make $13 per day roughly plus whatever the time expiration value is. The stock goes up - you make money. The stock goes down - you make money up until this little hashtag mark right there.

You'll make money up to that point. Remember all these things are taken into account, so the white line is the current line. You're not going to be making money right away. If this drops tomorrow within a few minutes, you're going to be down about $600-$700.

But with the time that Theta decay you're going to get closer and closer to the green line at expiration. That allows you to make $630 so long as it's above that 740 level. Those are the strike prices we chose.

If we decide to go further out 720 and I get protection at 700, I'm a little bit safer. That's because I am wider, but I'm making less money.

I would be making $205 in this case. But I'm a much wider and further out than the 735-740 level. You can see how this works. By selling these verticals, it allows you to create money month after month. You can also do this by buying verticals, but then you need the stock to move in your favor.

Strategy #4 - Create Iron Condor

The next strategy would be to add on to this, and that is to create an iron condor. If we look at this 720-700 level, this is vertical. And we could create this vertical by simply selling a vertical, and it will put it together for us.

I could do 725-690 and analyze the trade. Here's my initial vertical and then what I can do the Iron Condor. I'll go to 920, and I'll sell it. We'll do a vertical and analyze the trade.

What I can do is go to play around with these strike prices. You can see how I've created a proportional trade. As long as this stock stands somewhere between 900 level and 730 level I make money. It doesn't matter if it wiggles in here up and down. I make money as this white line gets closer to the green line with time as I move theoretical time forward.

You can see how I make money. And my maximum that I would make from this is $578.

How do they come up with that?

Well, it's simple. You take this one the put side that you're selling that is $362. Then you take this one $216. You put it together, and you get $578. I can start playing with the strike prices (735-695) and get a little closer on this one.

The profits will increase because I'm contracting my edges getting closer the chance of me succeeding is less. But I'm collecting more premium. This is the next strategy that you can use to make money every single month.

So far we covered:

  1. selling the upside calls
  2. the naked option
  3. the vertical
  4. the iron Condor

And now is the time for the fifth one.

Strategy #5 - The Calendar

I'm going to show you the calendar and the way how it works. Well, it works differently. Options decay slowly with time, and then they start accelerating.

As you start creating options, this point initially might be at 60 days, and it decays slower. And as you get into 40 days, it starts to pick up speed. As you get into 30 days, it picks up more speed. Fifteen days it picks up more speed.

Even at 100 days, they're still decaying. They become slower. What we do to create a calendar we buy a single one first, and then you sell one.

The one that you want to sell is the closing out the month. When you start looking at your contracts and you start closing things up the one you want to buy for protection is later out. That would be 64 days.

Quick example

Let's say if we're trading Amazon here at 810 and you can do this on the put side or the call side. We buy a single, and you can see that with purchasing a single you create this little graph that goes to the upside.

It's just like a standard call, but now what you need to do is sell premium. That's because you're selling to be able to make money every month. A business makes money every month - like selling products.

This is the way you do it as well in the option business. Here I sell a single, analyze the trade, and now you can see what that does. It calculates the differences between these prices and strike prices and the times and the date to create a picture that looks like this.

When you sell the one you're looking for downside when you're buying one you're looking for upside. In theory, this could be vertical, but since the time is offset putting them together creates a picture like this.

With time the one in March is going to be case slower than the one in February. That's the case since we have a March and February 810 calendar. February 1 is going to decay much quicker than the one in March. That is because right now we're in January. With time the difference on that you're making about $13 as I continue to move the date forward and the date. You can see you'll be making about $205 within about a week or two.

That is if the strike prices or the price of the stock stays between about 760 and 870. Volatility plays a huge role within calendars simply because you're a buyer of volatility. Since you're buying time, but in general you're looking for the stocks to stay around 760 to 870.

You could start skewing these things, but that is a little bit more of an advanced bonus.

Advanced area

Let's say I can go to 800 and now you can start rotating it 790. This will begin creating your diagonals, but if you keep the strike prices the same that is your calendar. You're making money through time exploration. You could also position them a little bit further out such as 820 and 820. That is the case if you're looking for more upside move and you want to still stay in that barrier.

You could move them a little bit to the upside - even 835 and 835. That way at least with time as the stock continues moving higher the white line will slowly get closer and closer to the green line. And you're going to be making a little more money.

Pay attention: The triangle of your calendar here is shifted a little bit to the right to be the upside. It has an upside bias. But if you have a little bit of a negative bias, you could also do something like 785. Then switch this to the puts, and now you can see you have a directional bias to the downside.

It comes down to:

  • your strategy
  • what strategy you like
  • the way that you like to trade

But in this case looking at price, the risk, the rewards this is another strategy that you could use to make money every single month.

Conclusion

You notice most of these strategies that we've done making money through this Theta decay. That's how you make money time and time again by using time in your favor.

That's how you make money from trading options, and this is some of the very core and primary option money-making strategies for monthly income.

This is a starting point to get you to see the bigger picture of how money is made and what trades you could do with options.

I hope you found it helpful in opening up your mind about trading options and some of the common strategies.

Author: Sasha Evdakov

Sasha is the creator of the Tradersfly and Rise2Learn. He focuses on high-level education speaking at events, writing books, and publishing video courses on business development, internet marketing, finance, and personal growth.

I'm Sasha, an educational entrepreneur and a stock trader. In addition to running my own online businesses, I also enjoy trading stocks and helping the individual investor understand the stock market. Let me share with you some techniques & concepts that I used over the last 10+ years to give you that edge in the market. Learn More

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