This article discusses the best options trading strategies for traders to make consistent profits.
Plus, I discuss how to ensure that almost every trade is a winner.
Many people buy calls and puts; that's gambling, not investing.
Selling option premium is the only predictable and consistent way to make money as a trader in the stock market.
Selling options is your best way to increase your income because the majority of options expire worthless.
I highly recommend selling puts because the stock market has a “long bias”, meaning that it goes up more than it goes down.
While people are oftentimes scared of “black swan” events and market crashes, you can easily 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 people buy 100 shares of Facebook, they don't automatically assume that it will go bankrupt. As a result, it's strange that people say that selling naked options is risky when it's much less risky than buying stock.
When selling puts, I prefer two specific options trading strategies:
Selling options is much less risky than buying stocks. Those who claim otherwise are likely not profitable traders
Naked puts: Let’s say that Facebook is currently trading at $170. We can sell a put contract with a strike price of $160 that expires 6 weeks in the future.
In exchange for agreeing to buy Facebook if it falls below $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), and as long as Facebook stays above $158 then this trade will be profitable.
I prefer selling naked puts because it’s simple, has low commissions, maximizes the premium received, protects against trading too many contracts and it offers a lot of flexibility when rolling the contracts (more on this later).
For smaller accounts, selling naked puts may not be capital efficient because it uses up a lot of buying power (so you'll have to trade spreads).
I trade a small account, and am up 75% so far in 2019, and trade mostly naked options.
Naked options offer inherent protection against trading too many contracts and therefore protects you from being forced to close out a position for a loss.
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.
This is very similar to the sale of the naked put.
To make this trade a spread, we also buy a contract with a strike price of $150 that expires 6 weeks in the future. In exchange, we pay $1 / share.
In total, we have sold a $160 put, bought a $150 put and receive ~$1 / share net credit (receive $2 for selling the put and we paid $1 for buying the put).
There are two advantages of selling a vertical credit spread:
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 (although we both have a better chance of getting hit by a car tomorrow than Facebook going bankrupt).
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 brokerage firm will limit the number of naked puts that you can sell to adjust for the maximum loss difference.
So why would I prefer to risk $15,800 to gain $200 instead of $900 to gain $100?
Because you're expected return is substantially higher when trading naked options.
There are numerous reasons why trading naked options is best:
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).
Remember, we only get paid by selling premium!
Many traders are tempted to sell 5x-10x as many vertical contracts to collect more premium since their broker allows them to trade substantially more spreads than naked options.
This is the biggest mistakes that options traders make.
By increasing the number of contracts they hold, they are increasing their risk and commissions / trading expenses.
Additionally, selling vertical credit spreads provides much less flexibility.
Let’s say that Facebook falls close to my strike price, with a naked put, I can easily “roll” that position by buying back the original $160 put and selling a $158 put with an expiration date of 2-3 weeks in the future.
This can usually be done for a credit (meaning that I’ll receive money even though I have also reduced my risk by agreeing to buy Facebook at $158, or $2 less than before).
With the vertical credit spread, if Facebook falls, I’ll have to buy back the original $160 put, sell the original $150 put and then roll out both legs by 2-3 weeks.
This is much harder and more expensive to do because the $150 put that I’d sell is practically worthless yet I have to allocate the time premium that I'll receive towards buying another put option in the future.
The time premium would serve me a lot better if it was allocated to reducing the size of the position or rolling to a more favorable strike price, instead of buying a worthless put option.
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.
Personally, I 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 $1,000+ / share and selling a naked put requires too much buying power.
However, in general, vertical credit spreads is not one of my favorite options trading strategies and options trading strategies for beginners.
I see a few of my students trade too many spreads. If the underlying stock ends up below the put they've sold, yet above the put they've purchased then their broker will force them to close the position because their account size is not large enough to roll / manage the position and it's also not large enough to take assignment.
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.
I've finally learned how to make consistent money in the stock market: SELL OPTION PREMIUM!
The way we setup trades permits us to be profitable 95%+ of the time. As a result, the biggest challenge is not whether you'll make money on a trade (because that's almost a given).
Instead, the biggest challenge is managing your size and buying power to ensure that if a trade goes against you, you're able to "bend but not break" so that you don't have to close out that position for a loss.
As a rule of thumb when trading stock options, if your position gets tested, you should roll out (extend duration) for a credit and either reduce your position size or improve your strike price.
Facebook is one of the largest companies in the world. If it happens to trade below $160, it’s very likely that if I continue to 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 I never recommend taking 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 3-6 weeks until it expires or I close out the options trade.
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 amount of premium received while also reducing your risk.
This is why selling naked options is my favorite options trading strategy and trading options is the most successful options strategy.
Making money in the stock market is all about estimating the probabilities of expected outcomes. Selling options is the only strategy where the expected return is exceptionally high.
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.
The third best options trading strategy is 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 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).
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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 a straddle 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 of time decay.
My problem with straddles is that it requires more maintenance and babysitting (and I do not like selling calls).
If I sell the $160 naked put on FB, I can login to 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 or vertical credit spreads and do not use straddles / strangles as viable options trading strategies.
There are many stock options strategies, but the best is one is to 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 selling 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 reduce your size or roll to a more favorable strike price.
Selling ATM straddles, and managing the position at 25%, has enormous profit potential, but I don’t do it because of the higher commissions, increased anxiety / time required to monitor the position and the high likelihood of the calls getting challenged.
Due to two-sided market action in 2018, I have begun selling strangles. A strangle is a put and a call.
In 2017, this wasn’t advisable because the calls would usually get tested. But with the market being highly volatile in early 2018, it makes sense for us to take advantage of both sides (the put and the call side) and to collect as much premium as possible.
Also, selling both a put and a call doesn’t use up any more buying power than selling just one side.
For example, if FB is currently trading around $170, I would sell the $155 put and the $185 call. This is called a strangle.
This is an efficient usage of capital and doesn’t use up any additional buying power because Facebook cannot be above $185 (to challenge the call side) and below $155 (to challenge the put side) at the same time.
As a result, in 2018, I’ve done extremely well by selling strangles and consider it one of the better options trading strategies.
For much of this year, I have only been selling puts.
And I've been incredibly patient.
In my opinion, selling calls on a regular basis requires way too much babysitting and stress.
Over the past 10 years, the S&P 500 has increased in price by ~450%.
A trader simply cannot collect enough premium to overcome bullish drift.
I've made money by selling calls (primarily in Q4 of 2018), but even in May 2019, I did not sell calls.
The results have been great, as my smaller account is up 75% YTD and my larger account is up ~40% YTD.
I (David Jaffee) help people become consistently profitable traders while minimizing risk. I graduated from an Ivy League University and worked at some of Wall Street's most successful investment banks. Subscribe to my YouTube channel for valuable videos - BestStockStrategy YouTube Channel. Finally, if you're looking to Land a Finance Job, then I've put together the best step-by-step course at : LandaFinanceJob.com
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