Hi friends. Sorry I haven’t posted, I’ve been very busy adjusting to nomad life but I am really back now.
I hope you are having a great day, I am in amazing Boracay in the Philippines and it is… raining. But a rainy day in Boracay is still a great day.
I thought I would share a simple option selling strategy that you can use in your own trading. It is very hands off and beginner friendly but it is also a strategy I still trade now from time to time.
But before I begin, as always, I am not a financial advisor. I am sharing my journey and what has worked for me. I do not know your life situation or risk tolerance. I hope you find my content educational but seek out other traders and resources as well as a financial advisor who understands options. In the meantime, you can start paper trading this strategy right away and I do recommend that. Paper trading is extremely useful when adding a new trading strategy you are unfamiliar with.
With that said, let’s get into the trade. Today in part 1, I’m going to give you a very brief overview of option selling. Then I am going to talk about the put credit spread, which is the core concept of this strategy. Next time, in part 2 I will give the specific trade – what to trade, when to trade, and when to exit using the put credit spread approach. Then in part 3 I will wrap it up by touching on being creative as a trader and an example of how you might customize a strategy like this one. OK, let’s begin.
Option Selling Overview
A proper introduction to option selling would take an entire book or more. I’ll suggest some of those in a link below. This overview will also be slightly simplified. At its core option selling is just like being an insurance company. Only, instead of insuring a house or a car, you are insuring the stock market (or some other market).
Just as an insurance company is paid to take on the risk of losing your home, an option seller is taking on the risk of a market downturn. Also like an insurance company, you will normally leave some amount of padding between where the market is and where you start being responsible for losses. In insurance terms, a “deductable”. Let’s look at a simple example selling insurance on UBER.
There is a lot on here, but just focus on the highlighted row. Just focus on the list on the right. These are called put options and act like downside insurance. Each row on the right is one of these “insurance policies” that you could sell. I’ve selected one that expires on September 15th (today is June 28). The option on this row has a “strike price” of 40. Selling this put option makes me responsible for losses below $40. Uber is currently 43.83 so that makes me safe from the first $383 of losses – note stock options work in 100 share increments per 1 option.
Below 40 I am responsible for the losses and if UBER went to 0 I would lose the entire amount of $4000. By selling this policy I collect around $152 which I would still keep so actual max loss is $4000 – $152 or $3848. My maximum return is the $152 if UBER remains above 40 by September 15. This is a return on the $3848 risk of 4% in 79 days. Not exciting but not bad. Also to be clear, that is the maximum return, some trades will make less or lose money.
Put Credit Spreads
OK, that’s a nice start but now let’s discuss put credit spreads.
$4000 is a lot of money. What if you don’t want to risk that much? Well, just as smaller insurance companies often buy catastrophic insurance from large ones like Lloyds of London – you can also buy catastrophic insurance further down the chain. Let’s use the $37.50 strike put option from that list before.
We will sell the $40 strike put option and at the same time buy a $37.50 strike put option. This is sent as a single order. Since the $40 option is closer it is higher risk and you are paid more for it than what you have to pay out for the $37.50 option you are buying. So you still get paid a credit, in this case $60. If UBER stays above $40 by September 15, you keep the full $60 as profit. The most you can lose is the difference between the strikes so $2.50 or actually $250 since, again, options are based on 100 shares. But you keep the $60 no matter what, so really your max loss is $190.
This makes your return in the best case scenario 31% in 79 days. That is phenomenal. Of course, it doesn’t happen every time and sometimes you will lose the maximum. That is why you should never put all of your money into any single one of these.
OK, that’s a quick and dirty introduction to a very popular option selling technique. In the next video, I will use this structure with some specific rules covering what to trade, when to trade it, and how to manage the trade once you are in it. Please consider subscribing to my YouTube channel as well as following me here for more updates.