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Top 8 Reasons Why Selling Option Premium is the Best Way to Increase Income – and Why People are Scared to Start

Approximate Reading Time: 5 Minutes

Summary

  • Selling option premium (primarily puts) has a high probability of profit
  • You can consistently make small profits that, with time, compound into much larger gains
  • Financial advisors almost always perform poorly, but people tolerate it because they believe they cannot do better when managing their own money plus they don’t want to assume personal responsibility for their investment decisions
  • People also mistakenly believe that selling option premium are risky, yet it’s much less risky than most other types of investments (including buying & selling stocks)

Before we get into the reasons why selling option premium trading is the best way to increase your income, I want to reiterate that this is not a get-rich quick scheme.

You will not have trades that are huge winners, instead you’ll have a large number of trades that are small winners.

Some trades will lose money, but as long as you don’t get greedy, and trade too large, then you’ll be okay.

In the stock market, there is no secret strategy that will achieve massive returns; anytime someone proclaims that they’re special, or that they’re a guru, you should run.

Selling option premium is the only strategy that I have come across where the odds are substantially in your favor; it’s the easiest way to rapidly increase your wealth for the following reasons:

  1. Easy to get started – There are few barriers to entry. You can open an account in a few hours and begin learning a skill by dedicating just a few minutes a day. I recommend opening an account with OptionsHouse – they are reliable, easy to use & low-cost (recently OptionsHouse was acquired by E*Trade).
  2. Earn money from anywhere – A smartphone is the only required equipment. You can be location-independent and make money while traveling (as long as your phone is able to connect to the internet).
  3. No selling required – There’s no need to create a website, generate leads or sell a product. You’re don’t need to spend time marketing, blogging or building a team.
  4. High probability of profit – Options have a high probability of expiring worthless; the few trades that don’t expire worthless can usually be managed and closed for a profit, a small loss or rolled into the future.
  5. Liquidity – When buying or selling a house, the process takes months and there are numerous fees that must be paid. When selling options, a trade is executed instantly and the cost is minimal.
  6. Minimal time investment – You can spend just a few minutes a day monitoring your positions and placing trades.
  7. Many people find trading enjoyable – You can be your own boss and take control of your financial future. You will gain insight into human behavior and learn a skill that can be used for life. Also, it’s very easy to learn as long as you don’t overwhelm yourself with unnecessary information.
  8. It’s scalable and can be incredibly lucrative – Whether you have $1,000 or $10,000,000, you don’t need any employees nor do you have to change your methodology as your assets grow. Plus, with the power of compounding, by doubling your money every year, you can become incredibly wealthy. Starting off with $20,000 and doubling your money for 10 years will leave you with ~7x more money than if you had made $300,000 a year during that span.

When trading options, people get in trouble when they become greedy and sell too many contracts. They also run into trouble when they hold out hope that a losing position will become a winner instead of proactively managing the position.

As long as you trade highly liquid underlyings, and keep your number of contracts low, you shouldn’t suffer large losses.

Psychologically, losses are much more powerful than gains.

As a result, do yourself a favor, and avoid trading too many contracts.

Almost all of the horror stories that are associated with options trading can be attributed to trading too large. When deployed correctly, selling options is substantially better than buying and holding stocks.

Stocks go up ~53% of the time, yet you can sell options that expire worthless ~85%-~90% of the time, with less risk & volatility of buying stocks.

Selling Option Premium Conclusion

Selling options premium is the best way to increase your income. The biggest reason I love it is because it doesn’t require a substantial time investment; there is no need to create a product, pay for advertising or build an email list. Plus, the profit potential is substantially higher than most other strategies.

The financial services industry does not want you to manage your own money. They make their customers feel inferior yet financial advisors almost always performs poorly.

Overconfidence is the biggest reason why people suffer major losses. Be careful not to trade too many contracts so that you can be successful & substantially increase your wealth.

The Top 3 Stock Option Strategies and How to Ensure that Almost Every Trade is a Winner

Approximate Reading Time: 8 Minutes

Summary

  • Selling stock market options (primarily put options) is your best strategy
  • Specifically, selling naked puts & vertical credit spreads are the trade types that I prefer
  • Selling straddles seems to work well, but it is more stressful, so I don’t use this strategy
  • To ensure that almost every trade is a winner, you may have to “roll out” your tested trades for a credit

Selling options is your best way to increase your income because the majority of options expire worthless.

I highly recommend selling only puts because the stock market has a “long bias”, meaning that it goes up more than it goes down; and while people are oftentimes scared of “black swan” events and market crashes, the reality is that you can protect yourself against a stock market collapse by trading small and also selling puts with a strike price that’s ~10% below the current price of the underlying.

When selling puts, I prefer two strategies:

  1. Naked puts
  2. Vertical credit spreads

Naked puts: Let’s say that Facebook is currently trading at $170. We can sell a contract with a strike price of $160 that expires 6 weeks in the future. In exchange for assuming the risk of buying Facebook at $160, we receive a credit (“option premium” or “premium”) of $2 / share. Remember that 1 contract equals 100 shares, so for every contract we sell, we’ll receive $200 (1 contract x $2 credit / share).

If Facebook trades above $160 at the time of expiration, our option expires worthless and we keep the entire $200.

In this trade, our break even point is $158 (excluding commissions), so as long as Facebook stays above $158 then this trade will be profitable.

I like selling naked puts because it’s simple, has low commissions and it offers a lot of flexibility when rolling the contract (more on this later).

The downside to selling naked puts is that it uses up a lot of buying power, which means that you cannot trade as many naked options.

However, I actually think this is beneficial because it protects you from trading too many contracts.

Vertical credit spreads: Let’s say that Facebook is currently trading at $170. We can sell a contract with a strike price of $160 that expires 6 weeks in the future. In exchange for assuming the risk of buying Facebook at $160, we receive a credit of $2 / share. At the same time, we also buy a contract with a strike price of $150 that expires 6 weeks in the future. In exchange, we pay $1 / share. So, we have sold a $160 put, bought a $150 put and receive ~$1 / share net credit (receive $2 for selling the put and paid $1 for buying the put).

There are two advantages of selling a vertical credit spread:

  1. It’s a defined risk trade, meaning you know exactly how much you can lose
  2. The buying power reduction is much less

In the example above, the maximum loss is $10 per share less the $1 credit, so for every contract you sell, your maximum loss is $900 and your maximum gain is $100. If, at the end of six weeks, Facebook is trading above $160, you will make $100 / contract. If Facebook trades between $150 – $160, you’ll be forced to purchase Facebook stock at $160 / share. If Facebook trades below $150, you’ll still be forced to purchase Facebook stock at $160 / share, but you can also sell Facebook at $150 / share, so you will lose ~$900 / contract ($10 per share less the $1 per share in premium).

Don’t worry if this doesn’t make sense at this moment. It’s not rocket science and once you’re exposed to vertical credit spreads with greater frequency, you’ll naturally begin to understand it.

By selling naked puts, your maximum loss would occur if Facebook went bankrupt and fell to $0. As a result, you’d have substantially greater potential risk by selling naked puts. Theoretically, you could lose $158 / share (forced to buy Facebook at $160 less the $2 / share of premium received) since 1 contract = 100 shares, for every contract sold, you could lose: $158 x 100 shares = $15,800.

Since you can lose $15,800 for every naked contract of FB vs. $900 for every vertical credit spread contract, your online broker will limit the number of naked puts that you can sell to adjust for the maximum loss differences.

So why would I personally prefer to risk $15,800 to gain $200 instead of $900 to gain $100?

There are numerous reasons. The first is that by trading a naked put I receive twice as much premium ($200 / contract when selling a naked put vs. $100 / contract when selling a vertical credit spread). To compensate for that monetary difference, I might be tempted to sell 2x as many vertical contracts, which increases my risk and my commissions / trading expenses.

Additionally, selling vertical credit spreads affords me less flexibility. Let’s say that Facebook falls to $162, if I sold the naked put, I can “roll” that position by buying back the original $160 put and selling a $158 put with an expiration date of 2-3 weeks farther out.

This can usually be done for a credit (meaning that I’ll receive money even though I have reduced the price that I’ll be forced to buy Facebook from $160 to $158).

With the vertical credit spread, if Facebook falls to $162, I’ll have to buy back the original $160 put, sell the original $150 put and then roll out both legs 2-3 weeks.

This is harder to do.

Also, because my original credit was less ($100 / contract for the credit spread), my break even point is also higher for the vertical credit spread ($159 vs $158 for the naked put).

My commissions when rolling a vertical credit spread will be approximately 2x more and the credit I’ll receive when rolling out the position will also be less since I’m buying an option when deploying a vertical credit spread.

I also have been burned a few times with vertical credit spreads. I once lost ~$1,000,000 in 2 days because I traded way too large. I traded 5,000 contracts (or 500,000 shares of stock) and the market temporarily plummeted. My broker called me for a margin call and forcibly closed out my positions for a large loss. Had I traded naked options instead, I would have only been able to trade ~500 contracts, and then I simply could have rolled the contracts forward.

Instead of losing ~$1,000,000, I actually would have made money.

I do prefer using vertical credit spreads when dealing with expensive stocks such as Amazon and Google since these stocks trade for $500+ / share, selling a naked put requires too much buying power.

So let’s assume that we’ll mostly sell naked puts, a logical question (using the Facebook example above) is: why would would anyone risk $15,800 to gain $200? And the answer is…the odds are strongly in your favor. If Facebook is currently trading at $170 / share, the chances are ~50% that it will be trading above or below $170 in 6 weeks. Additionally, even if it’s trading below $170, as long as it stays above $160, I get to keep the $200 / contract.

Even though we have $10 / share of “cushion” by selling the $160 put (current price of $170 – $160 strike price), it’s possible that the market will correct in the future which can drop the price of Facebook below $160. If that occurs, it’s easy to simply roll the trade forward for a credit.

As a rule of thumb in stock market, if your position gets tests, you should roll out for a credit and extend duration. 

Facebook is one of the biggest companies in the world. If it happens to trade below $160, it’s likely that as long as I roll out the position (and receive money every time I do so), then eventually Facebook will rally above $160 so that the position expires worthless.

While we try to never take ownership of stock – I never want to own actual Facebook stock and would prefer to roll the position until it expires worthless – I recommend only selling puts on positions that you wouldn’t mind owning.

For example, if it wouldn’t bother me to own 1,000 shares of Facebook at $160 / share, then I would sell 10 put contracts of FB with a strike of $160 (as long as the premium received is high enough).

In general, only about 5%-10% of my trades will ever get tested; so 90%-95% of them will expire worthless. Of the 5%-10% that get tested, I normally only have to roll out the position by a few weeks or months until it shows me a profit.

And that’s why everyone should risk $15,800 to gain $200: the probability of profit is extremely high and, even in the worst case scenario, you can roll out the position to continuously increase the gains while also reducing the maximum loss.

Last thing (and feel free to skip this part because it’s more advanced and I’ll write more about it in other posts), selling at-the-money (“ATM”) straddles and closing out the trade at 25% of maximum profit has a very high success rate.

This is the third best way to make money with stock options (selling ATM straddles).

For example, let’s say that Facebook is currently trading at $170. I could sell an ATM straddle (selling a put and a call with a strike price of $170 that expires in 6 weeks) and receive $8.50 / share!

If I sell 10 contracts, that means I’ll immediately receive $8,500 in premium – that’s a lot of money!

The reason I don’t like selling straddles is because I usually only trade 5-10 underlying stocks (FB, LMT, AMZN, etc.) and I believe that, long-term, all of these stocks will increase in price.

And by selling a straddle, I also have to sell a call (which means that I’m betting that the stock will FALL in price).

My concern with ATM straddles is that if FB is currently trading at $170, I believe there is a good chance it will trade above $178.50 in 6 weeks (current price of $170 plus $8.50 in option premium received) – which means that once it crosses $178.50, the trade will show me a loss.

However, research has shown that to maximize profits, I would close the trade once I have a 25% profit (so I would place the trade, then automatically place a limit order to close out the position once the option premium decreased to ~$6.38.)

As time passes, the option will decrease in value. If I place the trade, and then wait 10 days, and FB is still trading at $170, then the contracts I sold for $8.50 may only be trading for around $6.38 because there is less time until those contracts expire.

My problem with straddles is that it requires more maintenance and babysitting.

If I sell the $160 naked put on FB, I can log into my account once a day for a few minutes. But, if I sell the ATM straddle, then I’m going to be much more anxious if FB begins trading significantly above or below $170. Yes, I realize that profiting from straddles, and closing out at 25% of maximum profit, is a high probability trade, but when factoring in the increased closing trade commissions and the stress of monitoring the position, I prefer to stick with naked options and vertical credit spreads.

Stock Market Options Trading Strategies Conclusion

Sell put options, preferably naked puts. But if the stock market price of the underlying security is too high, such as AMZN, then use vertical credit spreads.

Avoid the temptation to trade too many contracts when deploying vertical credit spreads. Learn from my mistake, I lost $1,000,000 in 2 days because I traded too large – had I used naked puts instead, I would have made money on the trade instead.

If any of your positions get tested, you should roll out for a credit and extend duration.

Selling ATM straddles, and managing the position at 25%, has enormous profit potential, but I don’t do it because of the higher commissions and increased anxiety / time required to monitor the position.

The Best Online Stock Broker – And How to Get Started & Take Those First Steps

Approximate Reading Time: 5 Minutes Time Required to Open an Account: 2 hours work plus 5-6 days waiting period

Summary

  • I recommend OptionsHouse. While I’ve used Fidelity & Interactive Stock Broker previously, I’ve found OptionsHouse to provide the best value & customer support
  • I place all my trades using their Android App, and have never had an issue (yes, I know it has bad reviews but I use it every day)

Choosing an online stock broker can be very stressful – and everyone has an opinion. The good news is that there aren’t substantial differences between the top online brokers. Also, your income will not be materially impacted by your choice – so please don’t get anxious when deciding.

I highly recommend OptionsHouse for the following reasons (you may not understand all of the reasons below, don’t worry about it, it’s not super important):

  1. It’s cheap – $4.95 base plus 50 cents per contract
  2. Their customer support is personable, knowledgeable and very responsive
  3. Their App is great (I don’t use the desktop software) & I can place trades from any location
  4. I can close trades without paying commission as long as the option price is 10 cents or less
  5. I frequently get filled at a better price than my limit price (price improvement: I’ll sell for a slightly higher price & buy for a slightly lower price)

I’ve read a few complaints about OptionsHouse’s lack of research, but if you’re reading research reports then you probably won’t make any money. I know this last statement is controversial, but most of the available stock analysis should be viewed as entertainment. Yes, of course an occasional person will be correct with their analysis and predictions, but the odds are not good and, overall, reading research (or listening to “stock experts” on CNBC) is not a good usage of time.

Prior to selecting OptionsHouse, I tried Interactive Brokers & Fidelity. They were okay. Interactive stock Brokers is difficult to use. Fidelity is expensive, and it felt more antiquated and less flexible.

To open an OptionsHouse account, you’ll need a SSN (or ITIN) number. There is no account minimum to open an account (meaning that you can open an account with $0 if you’d like). However, you’ll need to deposit at least $2,000 in order to have a margin account and be approved for options trading.

OptionsHouse is currently providing 100 commission-free trades when you open and fund an account with $5,000 or more within 60 days of opening your account.

The OptionsHouse signup link is an affiliate link. I earn 30 free trades if you click the link to signup and fund your account with a minimum of $1,000 within the first 60 days. While it may seem that I have a conflict of interest by recommending a company that I have an affiliate relationship, I wouldn’t use or recommend OptionsHouse unless they were the best.

Once your account is open, OptionsHouse will automatically create a PaperTrade account where you can place fictitious trades without risking any money. You can place practice trades in your PaperTrade account to learn the skill of trading options.

Remember that when learning a new skill, it’s important to not become overwhelmed. Try to focus on taking small steps (open an account, place a few trades in the practice account, etc.) so that you make incremental progress towards your goal of doubling your money every year.

Stock Broker Conclusion

I recommend OptionsHouse (click the link to signup) – it combines great pricing, with excellent customer support and a good App.

When learning a new skill, focus on making incremental progress every day or week. For example, open an account one week, place a few practice trades the next – that way you’ll soon start to feel comfortable.

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