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Boosting Your Trading Income With Weekly Options Premium


It's well known that in in order to be truly successful in the financial markets, you'll need to be patient.

Rushing into day trades, buying premature breakouts and bounces, and short selling parabolic charts too early are surefire ways to send your trading account the way of the dodo. So, what to do with all that free time while you're waiting for the perfect time to strike? Uh, make more trades of course!

Ok - not exactly, but close. Unfortunately if you want this to work, you'll still have to be patient, but you can boost your trading income significantly in your downtime using a simple weekly options premium selling strategy. It's also a great option (see what I did there?) for those who have full time jobs, those with families that keep them busy and those with smaller trading accounts that can't avoid day trading regulations like FINRA's pattern day trading rule.

Ok, so tell us. How do we generate more of those coveted things called dollars without doing much more of that unpleasant thing called work?

Over the last couple of years, I've dialed back my day trading significantly and migrated my trading to strategies that revolve around selling options premium, and in that time I've developed a reasonable system that seems to work pretty well and is a simple transition if you're already an active trader. Here's how it works:

Step 1: Identify your target

First, identify a few stocks that have recent catalysts (earnings, new contracts, significant technical breakouts are all great). Don't try to find stocks that have potential catalysts in the near future; in fact, you should avoid those stocks because those upcoming catalysts add significant unpredictable risk that you want to avoid in this strategy. Instead, look for stocks that have made significant moves up or down within the last few days, and are likely to either stall or reverse direction within the next week or so. Here's a great example of the type of chart I'm looking for (SHAK):


Shake Shack Inc (SHAK) declines significantly following earnings

Step 2: Predict the future

That's right, in order for this to work you need to predict the future. The good news is you don't have to be completely accurate ... just don't be horribly inaccurate. Since you're already looking at a chart that's quite extended to the upside or downside, for a company which most likely has no significant upcoming short-term catalysts, hopefully that won't be too difficult. Identify an area on the chart where you could reasonably expect the current move to stall and/or reverse.

Note that it doesn't matter if you're exactly right here. You're not trying to time the exact top or bottom like you would in a day trade (although it's nice when you do 'cause you get paid even faster). Instead, you just want to identify an area on the chart where you can say "I don't really know for sure, but there's probably a 65-70% chance that this stock won't enter this range within the next week or so, and if it does, there's probably a good chance it won't stay there for long." On the chart above, for example, given that in less than a month the stock has shed nearly 50% of its market cap, and it's been selling off for the last four days right into a support area in the $60s, we can probably reasonably expect that it will at least need a little bit of a bounce or a consolidation within the next few bucks to the downside.

Keep this price area in mind.

Step 3: Use those "options" things people keep babbling about

So you've got a decent chart, you've got a price range you believe the stock shouldn't violate too badly within the next week, and you're reasonably sure you're not wrong. Now what?

This is the point where you need to know something about options. The simplest type of options trade outside of simply buying calls and puts (and the one I use most often for this strategy) is called a vertical spread. If you don't know how spreads work, read up on it first ... it's not terribly complex, but you need to understand it in order to make these trades. Basically, you're going to capitalize on the passage of time by selling options at strike prices the stock should not violate within the next week. On the chart above, if I assume the stock probably shouldn't go much lower than $60 in the next week, I might sell a $60 PUT for $0.40 and buy a $59 PUT for $0.20, netting a credit of $0.20 per contract, expiring in one week.

In this way, as long as the stock doesn't close below $60 (specifically, $59.80, since I would collect a $0.20 premium) on the options' expiration date, I will collect $20 per contract.

Boom. Like magic, you're literally making money due to the passage of time. Nice, right?

The reason this works so well is that these types of trades typically already have fading momentum. If the stock is rising, people will want to take profits, introducing price resistance as the profit-takers begin to outweigh the buyers. If it's falling, the number of fearful sellers will begin to dwindle and value buyers will swoop in to support the price. Econ 101 right? Supply and demand. Your only goal in this strategy is to identify stocks that are likely to start losing momentum soon, and sell some options you expect will expire worthless in order to collect the premium. That brings us to the final step:

Step 4: Wait

The final step is just to wait and see if you're right. When you enter these trades you've already defined your risk (more on that in a moment) so there's not much to do. I typically enter these trades on Thursday or Friday with an expiration date on the options of the following Friday. I find that as long as I'm trading the right chart, a one week timeframe allows me to get paid quickly if I'm right, get paid really quickly if I'm really right, and still allows the trade to work in the end if my timing is off a little. Also, entering on Friday limits my exposure by giving me two days of premium collection while the market is closed.

Risks and considerations:

Like any trading strategy, this one involves risks and requires you to follow rules. Here are some of the things I consider and why:

  • Return on investment: Spread trades have a max profit. Because of this, I won't take one of these trades unless I can collect at least 20% of the spread width. This means that if I make the maximum profit, I will get at least a 20% ROI on average, which is enough to make consistent long-term gains given a 65-70% probability of success.
  • Probability of profit: Speaking of probabilities, all options trades have a rough probability of profit too. I want my probability of profit to be at least 65%, along with that 20% ROI.
  • Max loss: Don't be stupid. Understand that your max loss is the spread width minus the premium you collect, and will usually be significantly more than your max profit. For obvious reasons, I seldom let these trades actually materialize into a max loss; I tend to try to cut the trade off if the loss grows to more than 20% of the max loss.
  • Winners: I try to let winning trades run all the way to expiration if possible, but on average, I want about 90% of my winning trades to gain at least 90% of the max gain. This makes sure that when I do end up with the occasional max loss on a loser, it won't wipe out my last 4 or 5 gains!
  • Liquidity: This one is important: this really only works on stocks that have reasonable options liquidity. Obviously, the stock needs to have weekly options, and they need to have enough liquidity that you can trade enough contracts to make it worth it. I find the best types of stocks for these trades are big, well known companies with liquid options chains, like AMD, AAPL, FB, QCOM, and major ETFs and indexes. If I can get enough premium though, sometimes I only need to trade a few contracts to make the trade worth it.

Remember, your goal with this strategy isn't to pick tops and bottoms. It can work on sideways, slow-moving stocks as well, but I find combining the premium selling strategy with my day trading and swing trading strategies yields great results since the trades tend to work quickly, which allows me to run several of them each week. Each Thursday and Friday I spend the day looking around for stocks that have recently made big moves, and pick a few to sell spreads on, expiring the following Friday. Rinse and repeat.

So next time you're sitting around waiting for that chart to be "ready" to day trade or enter for a swing, take a look at the options chain and see if the passage of time can make you some coin in the mean time.

Until next time, happy trading!