by Traders Reserve | April 30, 2012 2:00 pm
Lately, the only way to make “consistent money” trading options is to sell them, not buy.
It seems foolproof – buy calls when you’re bullish; buy puts when you’re bearish. You know how much you can lose from the moment you initiate the trade.
But, more than 75% of stocks trade sideways over the long haul. That means only a quarter of stocks make a noticeable move up or down in a given time frame. And what do you need when you buy options? Movement!
Sellers, on the other hand, love “stuck” stocks. Trading ranges are profitable territory for sellers. Plus, they know how much they can WIN upfront, because they hit their jackpot the moment they make their trade!
If you have better things to do than to hope the underlying stocks move enough to make your long options profitable, I’ve got five rules to help you sell options for profits.
Rule 1: Use your whole account to trade, even if it’s a small one
Most buyers expect to lose their money and are OK walking away with empty pockets. To start winning consistently, you must get out of the buyer mindset.
Sellers don’t play with Vegas money or “risk capital.” That will get you blown out of the water, with no lifeboat to get back in to rescue yourself.
Your core portfolio is the best (and only) starting point for making options income. You’ve got stocks you love, stocks you hate, and stocks you’ve owned for so long that you can’t bear to part with them.
The best revenge on those “duds” is to make them pay you for your patience … and to sell some puts on stocks you wouldn’t mind owning someday, for good measure.
Rule 2: Tell the market when, and how much, to pay you right now
It’s not about how much money you have – it’s about how you can use it to make how much money you want in any given month.
Whether you’re working with $25K, $50K, $100K or more, set a target for each month. Two percent is very reasonable and translates into 24% a year. That’s better than the Dow, NASDAQ and S&P combined, most years!
With a $50,000 account, you need to make $1,000 a month to hit that 2% goal. Revise your goal a little higher, say to $1,500, to provide balance if any of your trades don’t work out.
Take a look at the option chain – you’ll probably find some very rich premiums that are yours for the taking! Then sell some calls against your “love to hate” stocks. With all that extra cash you used to leave on the table, you’ll start liking them again!
Rule 3: Get long on profits in a short time
Time may be money, but less time can mean even more money for option sellers.
Most buyers pick options that require a Herculean move from the stock to make them profitable. But, those out-of-the-money option values plummet as expiration nears. When the clock runs out, there’s no making back that cash – time is the buyer’s mortal enemy.
Sellers scoop up the money those buyers leave behind. Time is definitely your friend when you’re net-cash-positive during the life of your trade!
Selling options that expire in a couple weeks or, at most, a couple months is a proven strategy that provides consistent returns. Best of all, you can repeat the profit cycle every week or month to meet or even exceed your income goals.
Rule 4: Embrace your other best friend: volatility
Selling options on slumping stocks is only part of the fun. You can also profit from directional moves. Unlike the traditional buyer, who needs a big, one-way move, sellers are uniquely positioned to profit from movement in either direction.
Many “snoozy” stocks have highly volatile option chains (like Citigroup (NYSE:C)). Bigger volatility means bigger premiums for option sellers. You want options with some bounce — that is, volatility in the 25-35 range.
To get the fattest-possible premiums, you sell when volatility is at the higher end of that range and cash out when volatility contracts.
This is another way buyers get creamed – they buy and watch their option value plummet overnight, simply because the wind went out of their option’s sails … and blew the sellers’ way.
Rule 5: Run the bases for slow-motion, safer home runs
Option buyers don’t get rich from buying options. Sure, they can get the occasional big winner, but it’s usually canceled out by a bunch of losers.
Option sellers aren’t going to get rich overnight, either. But their winning average is far-more-impressive. Over time, a few dollars earned here and there can add up to a pretty nice chunk of change over time, especially when it’s reinvested.
The secret is to keep your monthly goal in mind at all times. And to not only identify target prices on your options, but also to set automatic buyback orders at 30% to 50% profitability. Buyers get caught up in guesswork and emotions, whereas sellers benefit from avoiding the fear and greed that plagues their buyer counterparts.
Bonus Rule: Don’t hope for returns — make them and keep them!
Yes, buyers know their risks before getting established. But so do sellers! Better yet, sellers are net-cash-positive from day one, and they keep that money and have it earning interest in their accounts.
The big disadvantage to buying is that you can lose all your money in one lousy trade. Sellers are far more realistic and disciplined in their expectations and trade management. Once you’ve “won,” which you do right away, you strive to keep the bulk of those returns.
Sure, sellers can have shares “called away” or “put” to them. But if you keep your options out-of-the-money, manage your expectations and adhere to profit targets, you can stay ahead of the market and be safer than your “buyer” counterparts. In fact, your only real risk is foregone profit!
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