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Today we're going to focus on getting paid as you wait for stocks to get cheaper. We're going to do it with options.
I want to share with you the strategy. Typically you need a little bit more capital in your account to do this. You also need options capability along with a higher level of options trading. That means you need to be able to sell naked options.
It gets a little more dangerous, but I want to show you an advanced strategy. That way you can see how money is made in the markets and seeing the bigger picture.
Keep in mind, of course, any trades that we discuss here are strictly for educational and illustrative purposes. I think all my viewers are smart enough to understand that. But by all means, here's a disclaimer for you in case.
Quick News & Updates
The live classes schedule was posted on the website. If you are a video charts member, go to the Traders Fly website and visit the live classes section at the top.
You'll see I've posted a great deal of scheduling for the next month and a half to two months. There's one or two that may change simply for the time, but if you're a video member, there's the list.
This is the scenario if you're not a video member. If you're on the newsletter list, there's also one or two that are for the newsletter subscribers.
By all means, go ahead and register for those classes and you'll get that link in the newsletter as they are sent out.
I'm also working on the Options Mastery #3 Course which is the Iron Condor Course. It probably will take me six weeks to ten weeks to wrap it up.
It has been filmed. We're doing the editing and the study guide. That's the next big project on the list.
And then also, later on, this weekend I will post a couple of bonus webinars for the technical analysis and members. People that have the technical analysis blue course will schedule a few webinars here sometime in the future to talk about Bollinger Bands and some other indicators. All of it is specifically related to technical analysis.
Getting Started With Getting Paid To Wait for Cheaper Stock Prices with Options
In either case, today's goal is we're going to take a look at getting paid to wait for that stock to come back to us. We're going to do it with options.
We're doing here a naked strategy> Naked means you're not covered or protected which means you can get the assignment. But if you have a market that's constantly heading higher or being strong this strategy is excellent.
The main reason is that it allows you to own this stock at a specific price. You can get that stock at that level, and you get paid to wait for it.
Because if it doesn't reach that level and it continues to get higher, you collect the premium. What's more, you get paid to wait.
There're a couple of caveats because nobody's going to give you anything in the market.
The big problems with this strategy are:
- You will get assigned the stock if it hits your price target.
- If it does hit your price target and you get assigned, you can also have some problems. Because if the stock continues to go lower against you, you're assigned at a higher price. Now usually it's not going to happen within a day where it's a 10 or 20 point difference on a $60 stock. However, it can continue to head lower if you got a stock assignment in which case you could sell out of the position.
- You need to have a more extensive capital account. That is necessary because you are going to be able to buy stocks. You need to have more capital in your account.
- You also need to be able to trade options - not regular options. You need to be able to trade and sell naked options. I believe it's a level 3 or level 4 options level as far as their requirements in your brokers.
Basics of How This Works
Let's take a look at how you get paid and some of the risks associated with it.
I'm going to do Caterpillar because it's been selling off quite a bit. It's an excellent example to somewhat use for this. They've got some accounting problems and things like that. If you're looking at this stock in the long haul, you want to own it in a retirement account, and they probably won't have any significant issues.
I mean it might come down to let's say 80. These are all theoretical concepts that I'm sharing with you. But let's say you assume well it'll probably go down a little bit further. But it's not going to be that bad.
I don't mind owning that stock at let's say 80 or 85 or 75 or something around that level. The main reason is that you can see the last time it was at 80 we were pretty much in November. That gives you a pullback from the highs if you look at it from about the $98 level. We go from the highs that offers you a pullback of about 18%. If you look at that little lower upper left area there in the box, you can see that 18%.
If you're looking to own this stock and you don't mind getting in it what you can do is sell a naked put.
This is how a naked strategy works. And this is great if you have a lot of capital in your account. Let's say millions upon millions of dollars. You can do this all day long especially on the market that heads higher.
Caterpillar Example - Step by Step
Let me show you how this works. What I'm going to do is pull up caterpillar.
Here's a caterpillar example. I'll go 71 days out. I could go to 40 days out. Because if I go to the 40 days out and I go to 75, that's what I'm looking at. At 43 days out I only get 27 cents of premium. And then I could be assigned the stock.
But it's only a 6%-7% chance that it would get there. At 80 I have a 14%-15% chance. In theory, it's an 85% chance for me if I'm the seller.
That's okay, but if you go out a little further in time and we go 70 days, you can get a bit further out for a bit more premium. Now granted you're getting paid to wait and since it's 70 days you get a little more money. That's because you're waiting longer.
Here what I can do is go to 75 days. It's about a 12% chance it will go against me. About a 90% chance that I'm going to get in and it'll expire worthlessly.
What I can do is to sell. We'll sell a single. When you sell that single, you get that 66 cents on that premium. Here you can see we're at 68 here's 58. So when you put in the trade it will be about 60. You can see it moving around.
Learn the concepts, learn the theory and then you'll understand how it works. What you're doing here is you're selling insurance on the stock. That means the person that buys the put if that stock gets to 75 they can put that stock to you at 75.
If it gets to 60, they can still sell it, and you're going to be forced to buy it at 75. You're selling insurance on this stock at that $75 price level.
Every day that stock stands still and doesn't move. You collect the Theta. In this example, our theta is $1.69. That's how much we make on a day-by-day basis if that stock doesn't move.
The white line is our current line, current profit and loss picture. On the left is the amount of money that we would make. The bottom is the price of the stock. You can see that the green line represents the expiration date.
That is the May 20th, 2017 at expiration you would make $62. That's because I'm selling one contract multiply that times 100 shares and you'd get $62 for that premium. That's simply for waiting.
Quick Note: you do need more capital for this. Buying power affects 7,500, so you need more capital. But you can see how powerful this can be especially as you start scaling up.
Let's say you sold ten of these. If I sold ten of these and now you're making about $596 simply for waiting for that stock to get to 75. You would see in your account at some point it could be harmful. That's because you can see that white line is the profit and loss today.
But remember as the stock keeps heading down that'll take a few days. I'll move this date time frame. I'll continue to move it up. And you see what happens to that white line.
That white line starts getting closer and closer based on the Theta to that green line. Let's say then it gets to 89. You can see I'm profit and loss of about $45. Then it continues to expire. There are a few more days that continue to tick. That white line continues to get closer.
As you run out of time before this gets all the way down to 74.99, you're perfectly fine. You're selling this insurance, and with time this continues to expire and decay, and you're collecting that time premium.
A Basic Perspective on All of This
Let's look at this from a basic perspective. It's time to backtrack a little bit.
At this point, you're here, and you're already profitable $400-$500. Absolutely.
You can get out of this at any time. You take the difference of what you sold it for and then what you bought it for. That's because of the time expiration. And you can get out of it earlier.
Absolutely. You can let this sit and expire, and you don't have to worry about it - as the price is above 75.
The big problem here is if it gets below 75. That way you are going to get assigned. You're going to get and be forced to get a hundred of those shares. That's the case because it's ten contracts that'll be a thousand of those shares.
Each contract represents 100 shares. In either case, it's going to cost you in a big way because you can see the buying power effect it's $75,000.
They're going to hold about $75,000 to make this trade. Or put this trade on. But you can make $600 for letting being there and letting things sit.
That's one of the great things about these trades. You can let them sit, and they'll continue to rot and expire, and you collect that premium or that theta.
In this case, it's $16 per day because we have more contracts.
A downside scenario: the flip side could happen. All of a sudden the stock could start bouncing. If it starts bouncing to a hundred, you could get out of it tomorrow. If all of a sudden all these problems go away the market goes higher you could get out of it tomorrow. You can get out of it next week, four weeks from now, five weeks from now.
It's possible for you to get out of it early. The big problem here and the risks that you need to understand is that if it gets to 75 and lower, you have issues.
It can get pretty bad as well. If you have one contract and you're at $73.
Let's say it takes a couple of weeks to get there. We'll continue to let things expire. You're down about $365 on one contract on selling one of these contracts. And it's below 75.
Well, you could get out of this, and you lose on the contract. You would repurchase it. What do you do? You create an opposite order or another case - let's right-click and analyze different rate.
You would repurchase it. The price difference would be different - you would be at a loss. That's because you're doing it later on. You could get out of it and buy it back for a worse amount, and therefore you would lose that difference. However, then you don't get assigned in the future.
The other option or the different variation that you could do is let it continue to go lower. Let's say it gets to 69 or something like that. Then if it expires you're still going to get assigned at 75. You still get to keep this premium because you sold it at 63, but you're getting assign.
Now you see that there're two significant problems:
- You could get out of this contract if it goes against you (let's say 73, 70 or 71) for whatever the price or rate is at the time. That's going to be wrong. You'll take your loss of $400, and then you don't have to worry about the assignment with the stock.
- You could let it continue to expire if you have the capital and get assigned the stock. The reason you put these trades on is to look for the future to hold onto these positions for the future. You don't mind buying it at a value. At this point, if you understand the rubber band concept that stocks get too far stretched down or too far stretched up they pull back.
A quick example of problem #2:
If you're getting that stock at 75, you're down at 23% from the highs of 100. It was pretty much at 100, and then it goes to 75. That's a 25% reduction.
You're getting it at a 25% reduced rate than what it was two months ago. Because this is a two-month (71 days) contract. I hope that makes sense of how to put these things on.
Facebook Example - Quick Review
I'll show you how this works on Facebook.
Before we get there here're a few notes of what is an excellent stock to do this on. Do this when stocks have a little more volatility. The right choice is stocks that are $50 and more. That's why I said you need a bit more capital.
If you do it on cheaper stocks or stocks that don't move around a lot here's the issue with this. When you go out with GE, you can see that this stock is at $29.
Let's say I want an option spread at somewhere around $28, $27. Here are only 10 cents. You only make $10 on the stock. If I sell this and I sell a single on the 26, and you analyze GE this is what you see.
If you look at it between the commissions, you're only making $9, it is a cheaper stock, so you need a little less capital. But you're not making as much premium.
Let's get started with a Facebook example:
When we look at Facebook, we go 70 days out. If I go for 40 days, you can't get as wide on the premium. Take a look at the chart, and we'll see that stock is at 137. I could say I missed the move. If it's a stock you want to be in, but you missed the movement there is that question.
Well, I could say I don't mind owning it at 130 even at 125. It seems like a good deal because I already missed it and it's been heading higher.
Pro tip: you want to do this strategy when you want to own the stock where you don't mind having the stock. It's not any riskier than doing other kinds of trades or strategies. You need to know and understand what you're doing.
A lot of people say that doing naked strategies is hazardous. If you know and understand the problems, then you know what's coming up in front.
If you don't understand the problems if you don't know what you're doing, then it's going to be very risky.
I'll share with you how to come to combat that risk here in a second - as we go in this second example.
Here on Facebook, we're looking at 130, 125 - that's my key. That's what I'm looking for.
We use 70 days, it's a little bit wider, and I can get more premium. Let's say 125 I can get about $1.55 on this one - that is excellent. But again it's a 20% chance it's going to go against me. That's 80% chance that'll expire. You can see right there 20% chance that is the probability in the money.
In either case, let's say I sell a single here. There's my sell a single I get a $1.54 which is a lot more than Caterpillar.
Quick note: more volatile - it's a higher price stock by about $30 as well. It contributes to that price of that stock.
Get rid of some of these price slices. Then reset our date back to today.
This is how things are positioned:
- the left side is the profit and loss that we have
- the bottom is our current price of the stock
- our theta is on the bottom as well
The Theta is $2.72, and it's crucial for you to remember that is exponential as we continue to make more money on a day to day expiration that theta continues to increase.
Now I get 2.78 and then as you continue you'll see that it continues and you make more from that Theta. Every day it continues to decay faster.
The slope here though it's a little misguiding. Because of the slope of it, since we're right in the center, you can see it's less Theta. But if you go to the apex that's where the Theta decay happens.
Let me backtrack this so you can see what that does. The Theta is $3.76. That's what we're doing on that whole contract. And then as I continue to move the date you can see right now we're at $4, then we get to $5. After that, we get to $6 and $7, and you can see $11, $12, $15, $17, $26 and $52 and then we're done.
In a nice sweet spot right here at the stock stays at 137 then that beta slowly starts to decrease. But the whole contract is accelerating to decay. It's going faster and faster to decay.
Here's the thing about this stock. If it stands still you make money. If it goes up, you make money because you're selling at the 125. That starts going down, and you start getting a little worried. What you can do is get out of the contract and buy back your contracts.
This is how: Right-click - analyze the opposite trade. You can buy back that contract.
Even if it goes to 110, you can buy back your contract. It's going to be at a bad rate, and you lose your $1447. You can still purchase it again.
Or you could let it expire. Then you get the stock assignment at 125 because that is what we are selling that stock for or that contract for.
Even if it's at 115, you'll still get assigned at 125. If it's 110, you get a signed at 125. Maybe it is 105, and you yet get assigned at 125 based on the number of shares that you sell.
In this case one - that means 100. If it were two - that would be 200 shares.
Maybe you have a good size account. And you're willing to spend about $25,000-$50,000 on these shares, but you think that they are pricey.
The thing is if you're looking to get 200 shares of Facebook this is what you do. You can sell contracts like this. And you can wait, and you can earn about $310 for merely waiting and selling the option premium.
What to Do To Minimize The Risk?
If you wanted to minimize your risk, you could protect yourself on these shares or contracts at another lower level.
This might be the case. You're okay with owning at 125, but if it starts getting to a hundred and so on there become some problems. The stock is moving very quickly. What you could do is buy another one.
You could buy a contract (105), and I'll buy a single right here, and I'll analyze that trade. You can see what this does. It caps my losses right there act 1863 which means this is vertical. You're selling a vertical which means if that stock even gets to 20 or 30 my max loss is 1863.
These are the things that we cover in the options business verticals class. There're a lot of these vertical strategies. But here's a little bit of a taste of what goes on. You can buy this position or contract for protection at 105.
Here if I bought at 105, the max I make is 139. That's because they take the difference between the 1.58 and the 19 cents right there and you get that 138. If I didn't do that, I could make a little more money because I make 1.57. If I get the protection, they take the difference, but it limits my losses and also it reduces the capital requirement.
My capital requirement is only $2,000. If I go and remove that - it's about $12,500 on the buying power effect.
There is another scenario as well. You can also go to 110. That way you limit that to 1375 - as your max risk. But you make a little bit less. You can see we only make 125 rather than before at the 105 you would have made 137. And if you didn't have it all, you'd make 156.
Pro tip: In either case the more protection that you get the less profit that you make. And it's a balance between how much profit you want to make versus how much risk you're willing to take on.
I've capped it at my max loss at 115. The most I'm willing to lose is 898. And then over here what I make is 102. It's not 155 or 156 like selling the naked, but I have a lot less risk.
And the buying power effect that comes into play is only about $1,000.
Can you still get assigned?
Yes absolutely. Because you're negative 1, anytime you're short 1, and it goes in the money that's a problem. In either case, you can see how powerful the strategy can be especially if you're willing to wait for the stock. And if you have a lot more capital, it's going to allow you to sell premium time and time again.
This is great for markets that are overextended especially in markets like this. But also markets that don't want to pull back or are pulling back lightly.
It allows you to make money while you wait for that stock to either come in or if the market keeps heading higher.
Let's say this stock goes into 150 or 160 while you let this expire and you could do another one another month or two later. And instead of at the 125 strike price level, you could move that to 135 or 140. You keep shifting it up with time, and eventually, it'll get a nice pullback, or there'll be a sell-off, and then you'll be forced to buy the stock.
Keep this in mind: it's hazardous if you don't understand what you're doing. You will get the stock if it goes against you. You need more capital. Not to mention if you're doing naked strategies like this you have to have a higher options trading level. You need that additional capital and if it goes against you - then you get that assignment.
Many people don't like getting the assignment, but if you're interested in owning that stock and you want it for the long haul, this is another strategy that you could consider.
If you understand the concept, there's nothing wrong with this strategy. You need to understand the risks that are involved.