GE was another stock over which I used this option trading strategy, although it played out a lot differently to the SPY trade. I think these three examples give you a good appreciation for how this strategy will evolve based on a few different scenarios. Don’t forgot to sign up for the IQ Newsletter on the left to receive your free options strategy workbook, and sample options trading plan.
Again, as the market had sold off, I thought I would take the opportunity to write a deep out-of-the-money put option.
My March put option had expired worthless and as the market looked like it had recovered from the recent correction I wanted to re-enter the trade. As above, the market looked strong, IBD had just confirmed a new uptrend so I wanted to increase my exposure on this option trade.
At this point, I rolled my put options up to be at-the-money and generate some more option premium. On June 16th, my $119 puts options were in the money as the SPY was trading at $111.96 and therefore I was required to buy 300 shares for $119.
At this point the market looked like it was resuming it’s uptrend so I took advantage of that, wrote a short term put option and made a quick $118 profit in 17 days. On December 28th I closed out the positions, I would have preferred to just let the my shares be called away, but I was having issues with my broker and was forced to transfer my account to Interactive Brokers who wouldn’t process the transfer if I had options with less than a week until expiry. In December, with GE trading just below $16, my puts were exercised and I bought another 200 shares of GE, and at the same time sold another 2 March 2010 $16 put options.
At December 28, 2010, my open stock and option trades were long 600 shares at $18.32 and short 6 March 2011, $18 calls.
In November, VMW was a stock that had been on my radar for a little while and I saw the recent sell off as a good opportunity to enter an option position on this stock.
The SPY trade shows how selling put and call options can help generate income, and reduce your average cost while you build a position in a stock.
For example, if there is a stock trading at $100 that you want to buy, you could sell a 1 month put option for $3 and leave the $10,000 in your account earning interest rather than buying the stock outright. One of my all time biggest trading mistakes was trying this strategy over AIG back in 2008.
In the first month, you sell just 1 option which means if you’re exercised you only have to buy 100 shares. However, from the last example above, you can really lose a lot of money if you don’t cut your losses. The market was in correction at this point and so I thought it was a good point to open the option trade. IBD had confirmed a new uptrend and I decided to write another 2 at-the-money put options to generate some premium. I bought them back and rolled the calls out until September and also reduced the strike price to $19 (which was still above my average cost) in order to capture slightly more option premium.
My total net profit from these stock and option trades over GE was sitting at $1,804.26 and I still had another $390 in time decay between now and March. With the stock trading around $84 I had made some money on my short put and I decided to roll up to the $85 strike. The GE example shows you how with this option strategy, it is still possible to make a profit even when the underlying stock declines significantly. Then in 1 month’s time, if the stock is trading above $100, you keep the premium and repeat the process. You now own 100 shares, and what you want to do is sell a 1 month call option with a strike price of $100 (or higher if you deem it appropriate) and receive around $2 in premium.
Stick to you trading rules and never fall in love with a stock, just because you have made money on it in the past. I needed to sell a long dated put option in order to generate enough option premium for the trade to be worthwhile. I could have sold calls that were at-the-money and generated more option premium but I was fairly confident that the SPY would recover by the end of the year.
The stock was still trading around my strike price and I was still happy to buy it for $75.
VMW is a bread and butter example of how selling short term puts options on stocks you are bullish on can help you generate monthly income with the potential to build a position in a stock. At the same time you sell a put at $95 and receive around $3 in option premium, so in total you receive another $5 in option premium. I decided not to write any new call options as I thought GE would continue to move up over the next few months and I didn’t want to restrict my potential profits. The option was now worth around $8 which meant if it expired worthless I would earn 10% in 2 months so I still saw the risk reward as positive. However, with the slightly reduced risk of the cash secured put options trading strategy I was happy with this result. Remember that you should only use this strategy on stocks you have a bullish outlook on and always stick to your pre-defined trading rules. Yes, this is less than the 3% you could have made if you sold 2 options, but your risk was also lower. There will always be plenty of opportunities out there and as mentioned on my post on the Top 10 Traits of Successful Options Traders, patience and being able to control your emotions are some of the keys to success in the stock market. I kind of broke my trading rules again here by doubling down on a losing stock, and I could have easily had another AIG on my hands. Never get sucked in to an options strategy just because the premiums are attractive, you have to make sure you understand the stock and the company and most importantly STICK TO YOUR TRADING RULES!! Obviously I was a little disappointed to have underperformed the market on this trade but I think using the options trading strategy outlined above, my risks were lower than if I invested directly in the SPY without using options trading.
Below are some examples of successes I have had in the market using this options trading strategy.
As you will see in the next example, using the cash secured put stock and options strategy, you can even profit when the market or underlying stock goes down.
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