Selling Weekly Options Puts for Income – Another AAPL Trade

Why I Love Selling Weekly Options

Selling weekly put options is one of my favorite techniques for generating income from the stock market. There are several reasons for this.

One, by selling weekly options we leave the least amount of time to expiration. The closer you are to expiration, the quicker that time value erodes. That means more premium in your pocket when compared to selling longer dated options.

Two, stocks are hard to predict. People have been trying for over 100 years to figure out how they can predict stock movements with accuracy. But when we shrink the time down to a week or less, stocks are much more predictable. It’s a lot easier to say that the stock will stay below a certain level within the next three days or stay above a certain level for the next two days.

Today’s Trade

The Chart

So with all that said, I wanted to walk you through a trade that I just started on Apple Computer.

As always, it begins with the chart. As you can see below, the price of Apple has been rising for quite a while. The blue line in the chart is the 50 day moving average. This is a pretty standard measurement to use for determining support and resistance. You can see that right as October began, Apple dropped down to the 50 day moving average, but then bounce upward. This is exactly the kind of situation we want to see when selling puts. The 50 day moving average in this case is providing support, meaning that it will be difficult for the stock to break below it. For AAPL in particular, there are about a million hedge and mutual funds out there waiting for such an opportunity to buy more.

Chart for AAPL

I noticed this chart pattern this morning when I was checking through my list of stocks that have weekly options. Since the chart looks good. It’s time to investigate deeper and look at the options.

 The Options Chain

AAPL 650-645 Put Chain

As you can see in the image above, I went into my brokerage account at optionsXpress and looked at the valuation of the various put options for Apple.

The first column in the table is the strike price, which is the execution price for the option.

The second column is the last traded price, which you can pretty much ignore for options. Options might trade frequently, or they might not. Since their value depends primarily on what the underlying security is doing, it doesn’t matter whether they have traded recently or not.

The third column is the bid. The bid is very important because this is probably how much will be selling your option for.

The fourth column is the ask which pretty much set the limit for the most you’ll get from the option.

The fifth column is the theoretical value, which is crucial.The theoretical value is calculated based on certain probabilistic mathematical models. The details aren’t that important, what you need to know is that they represent what the option should cost based on the current market conditions.

You can see that for the strike prices 655 and lower, the bids and the asks are higher than the theoretical values. This is what we want to see, it means that the options are overvalued compared to what the stock has actually done recently. When something is overvalued, that’s when you want to be selling it!

Based on the chart and the fact that there is only one day to expiration, I chose the 650 strike price.

So that’s step two.

The Bull Put Spread Trade

Now I have a decision to make. I can sell the put naked, meaning that I will hold cash my account against the chance that Apple goes below 650 by the end of tomorrow. This will work, but the downside is that for a price like $650, that’s a lot of cash to hold. For each contract that I sell I would need to have the $65,000 in cash in order to make about $50. That’s not a great use of my capital.

So, I have to look for other ways to enter this position. The easiest thing to do is to buy a lower strike price put and create a spread. Since the spread uses puts and has a bullish bias, it’s called a bull put spread.

What ends up doing was buying the 645 puts. This lowered my premium per contract to $14, but each contract now requires me to hold $500, the difference between a strike prices times a hundred, instead of $65,000.

$14 on an investment of 500 is a yield of 2.8%. $50 on a $65,000 investment is far, far less than 1%. So clearly the spread trade was the better choice here. It’s even better than my original AAPL trade post.

AAPL 650-645 Put Spread

Results

Regardless of which way you go, it’s extremely unlikely that Apple will crash below $650 by the end of trading tomorrow. This is why I love selling weekly options. You can construct extremely high probability trades. In the stock market, it’s all about the odds. You’re not going to get every trade right, but you can stack the odds in your favor. As long as you do that and have favorable risk versus reward ratios, then you can continue to create income for yourself just by sitting in front of your computer.

As you can see in this example, I sold 20 contracts. I chose 20 just because it makes for a $10,000 margin requirement, which is a very conservative allocation for my portfolio. So that’s another 280 bucks in my brokerage account provided Apple doesn’t crash 17 points and through all support in the next day and a half.

But the absolute numbers really aren’t as important as the percent returns. Where else can you get a 2.8% return in two days? If you can do that every week, then you’ll blow the professional money managers out of the water, all the while taking minimum risk.

See you tell me, why would you ever buy a stock again?

3% Returns in a Week with Selling Calls

 

Here at Selling Puts for Income, I usually talk about puts, obviously. After all, that’s what the site is about.

However, sometimes I also trade calls. This week, I actually traded two different positions with call spreads. So let’s take a quick look at those two different positions.

Position number one is on the SPY. On Monday, the SPY was trading around $141. I took a look at the Bollinger bands as well as other trending indicators and decided that it was unlikely that the SPY would rise above $143 by Friday. As a result, I sold the $144 call and bought the $146 call. This created a credit spread of six cents. For those of you who are into percentages, that is a 3% premium for a one-week trade. It’s now coming to the end of Friday, and as I expected, the SPY has dropped from where it was on Monday. So, I am keeping my premium.

Position number two was on the IWM. The IWM and was trading at about $81 and I opened a short call at $83 and a long call at $85. Again this was based on the technical analysis of the charts, and I was proven right when everything fell apart over the course of the week. The IW when state below 83 which means I keep get to keep all of my premium that I captured initially when I open the position. Again this was a 3% return for one-week trade.

This is one of the things that I love about selling options. I get to take calculated risks in very safe and conservative positions, and then all left to do is sit back and make sure that things don’t go against me too much. This is far preferable to buying a stock directly because then every change in the stock price actually changes your market response. Trading options is a lot simpler once you understand how to structure your positions in order to mitigate risk.

So if you think you might be interested in learning how to create 3 to 5% returns per week with a very little risk then you should learn how to sell calls and puts for income.

Selling Puts – Risk vs Risky and Overall Performance

From FullyInformed.com, we have this interesting piece today:

Put selling remains my favorite investment strategy. Over the past 4 decades, put selling has evolved into a very profitable means of compounding my capital, annually. When I started put selling in the mid 1970′s there were only a handful of stocks that had options available. Premiums were a lot higher in the mid 1970′s and over the years as more and more stocks had options introduced, option premiums have decreased except during periods of high volatility.

But with the maturing of the options market, there are today so many more stocks with options available and good option volumes on most, that it more than makes up for the decreased premiums through the wide variety of stocks available to select from.

The author here brings up a good point. Option volume is very important. Essentially, the more people there are trading a particular option, the close the bid and the ask quotes will be. The fewer people trading an option, the farther apart the quotes will be. We always want to go with the more liquid positions. The slippage (the extra amount you end up paying due to the bid-ask spread) on illiquid options can be enormous. This is critical if you want to exit your position through buying back the option. If the spread is large, you won’t be able to buy it back for less than you got in premium when you originally sold it.

A lot of readers email me with questions about my put selling strategy of trying to earn 1% a month or 12% annually. While most weeks I receive just one or two such emails, when the market is trending higher I receive a lot more. This is because as stock markets move higher it becomes more difficult to engage in put sellingout of the money puts and still earn at least 1% a month.

If you read the article “My Strategy Explained” you’ll understand that I aim for about 1% a month in income. My goal is 12% of my entire stock portfolio a year of consistent income. But it is important to remember that some months it may be difficult on certain stocks to receive 1% in a month. The goal though is 12% annually and a year is a long time. There will be periods when earning 1% is difficult but there will also be lots of periods when I can earn more than 1% in a month. This is the trade-off when investing through put selling.

Put Selling And The 12% Goal

I have a lot of investor friends. Many make more than 1% a month and many more than 12% a year. But not every year and not every month. Often what to them seemed like a great trade turned out to be a poor trade and ends with a loss. It only takes a few losses to wipe out months of gains. It only takes one bad year to wipe out years of gains.

The 12% return is my goal in put selling because I have found through every single market, bull and bear I can consistently earn 12% and continue to compound my capital.

12% annual earnings on a $100,000 portfolio compounds to over $300,000 in just 10 years. In 20 years it will compound to over 1 million dollars. 12 percent is a terrific return if it can be done consistently while controlling risk.

Just to be clear here, the author is talking about a 12% return on his entire portfolio, not on a per-trade basis. I doubt very much that 100% of his capital is in selling puts for income. If it is, then he would need to be doing so in a cash secured strategy or with bull put spreads.

Put Selling Is About Managing Risk

It is the 12% goal I care about with put selling. While it’s nice to earn 2% or more in a month when put selling, I know that overall the goal is 12% annually. That is what it will take to grow my capital according to my plan while managing risk. Not just risk of assignment, but risk of being assigned at overvalued prices which increases the likelihood of owning stock for long periods of time. If to earn 2% or more in a month I have to assume a higher risk of assignment it is necessary to be sure the stock is not overvalued.

Buy having monthly as well as an annual goal I can concentrate on either. When, as in the last two years, I reach my goal of 12% with months left in the year, I can pull back from riskier trades and sell for even half a percent because I have already reached by goal of 12%. Having clear objectives when put selling or trading stocks, controls emotion and the risk of stepping into a bad trade.

While I understand what he is saying here, I think it is even more important to focus on the particular trade at hand. How a trade effects the returns of your overall portfolio is nice to know, but never lose focus on the stock that the trade is on! If selling a put on a particular stock for income yields you 1%, great. If it yields you 2%, great. If it yields you anything, great. The key is to make sure you come out ahead like you planned in the first place!

Netflix Stock Put Selling Losses

Netflix stock is just one of many put selling disaster examples. Earlier this year Netflix stock traded over $200 and by July it had hit an intraday high of $300.70. It was highly overvalued and had a book value of just $7.40 and was trading at 68 X its PE. In less than two months it had fallen to below $130.00. I started receiving emails in early September from put selling investors caught in the collapse of Netflix. By the end of September I had received more than 1250 emails from put selling investors who had sold puts at strikes between $275.00 and $175.00. Many had been assigned shares which they did not want and many could not afford. One poor reader had 10 contracts assigned at $270.00 but the stock was trading at $155.00. 10 puts at $270.00 is $270,000.00 of capital.

Netflix was a stock heavily promoted by analysts and talked about endlessly on business media outlets. This is typical of analysts as they basically talk about the “stock of the month” like it was a new ice cream flavor brought to market. These talking heads know nothing about fundamentals, PE, book value and balance sheets let alone earnings projection. They know nothing about true value in a stock and certainly nothing about putselling. They are filling airtime.

Look at the Netflix Stock Put Option chart below for Jan 30 2012. Today three investors emailed to tell me that they had bought to close Jan 2013 $200 and $215 puts for staggering losses. They told me they had given up on Netflix Stock and were closing their put trades for huge losses. These are puts that were sold for $18.00 and $19.00 dollars of income when they sold the puts.  Such losses can sometimes take a lifetime to recover.

Put Selling against NetFlix Stock has led to enormous losses for many investorsPut Selling against NetFlix Stock has led to enormous losses for many investors

So why did these investors get caught? Because Netflix Stock was terribly overvalued and had been for over a year. But the constant chatter about the rise in Netflix Stock by Analysts and the lure of the enormous put premiums drew them into what became an emotion charged put selling trade. They forgot to manage risk.

At the very least as Netflix Stock rose, they might have considered a credit spread strategy of selling the higher put and buying a protective put. While they would still have had large losses, a credit spread would have assisted in limiting those losses.

Netflix Stock begs the question why would anyone put selling this stock?Netflix stock chart begs the question why would anyone choose put selling for this stock?

The Netflix stock chart above asks the question about why anyone would consider Netflix stock for put sellingat such lofty levels? It was typical investor exuberance that pushed this stock to such lofty levels. But with so many stocks to choose from for put selling, why choose Netflix? With exceptionally high put premiums, it drew a lot of investors into put selling. Those high put premiums were a sure sign from the market that Netflix stock was overvalued and could easily fall.

Well, yes and no. It is true that you, as an investor who is selling puts for income, must be aware of reversals in trend, “overvaluation” is entirely subjective. As the popular saying goes, the market can remain irrational longer than you can remain solvent. So NFLX was overvalued for a year? Entirely possible. But it kept going high and kept making put sellers lots of money, myself included.

You must watch out for changes in trend though. NFLX was an excellent candidate for selling puts for income all through 2010. At each trough in its cycle, it provided very strong support and yielded high premiums. So far, so good. The sophisticated put seller will know to never sell puts during a period when earnings reports are released. Earnings reports have the ability to drastically move the market, and we have seen that here. Once NFLX released a report that resulted in a downward break of its trendline, NFLX was no longer a candidate for put selling.

Nobody should have lost money selling puts on NFLX. It was only stupidly aggressive traders who did. If you follow Selling Puts for Income, you know that we analyze the chart each and every time we look to enter a trade. The stock must have a strong chart to even consider selling puts.

Put Selling Is Not Free Money

Put selling is for too many investors considered free money. It is not. It is not even close. The risk when selling puts is enormous and it does not matter which stock the put selling strategy has been applied to.

Put selling against overvalued stock is a disaster waiting to happen. Investors can do well for a while selling against overvalued stocks, but in most cases when the stock turns, it moves lower so quickly that the investor has no time to buy to close for small losses. Sometimes within a day or two the loss to close the sold puts can be huge.

True, but why would you be waiting for 2 days to close a losing position?

Risk Is Risk When It Comes To Put Selling

Put selling is incredibly risky for those who do not want to own the underlying stock. It is even riskier for those who fail to do any analysis of the underlying stock but simply look at the put premiums to select the fattest premium for put selling.

With proper management and stock selection, put selling is not risky. There is risk, yes, but risk and risky are two different things.

With my strategy I have a list of large cap dividend paying stocks that I like for put selling. They each have long histories of recovering from market meltdowns. When they become overvalued I move away and look at other stocks within my stock list.  Should they fall and I cannot roll down or out, I would own them and begin selling covered calls. As well should the stock fall further than expected I have cash always available to either pick up shares at fire sale prices OR sell puts at lower strikes which moves my average cost of held shares even lower.

Certainly an option (hah!), but I don’t think there is any need to restrict your selection of stocks to dividend paying companies only. As I’m sure we are all aware, dividends represent a minority of stock positions. Is that 2-5% per year worthwhile if you are going to end up selling covered calls anyways and making much more? In my book, the added flexibility that comes from examining the entire marketplace of weekly options is worth much more than the dividends that I might get if I get assigned a stock from a losing trade.

I keep 30% of my entire portfolio in cash to take advantage of pullbacks and crashes. With a stock market crash I only need to commit the cash part of my portfolio once every so many years to make huge gains which can then be averaged out for those years when my cash sits idle waiting for stock market sales.

That seems reasonable.

Put Selling Is Not A Race And It Is Not Gambling

My goal explained in my strategy is attainable and can be consistent if applied properly. Put selling is not a race and it certainly is not gambling. I do not believe that any option seller can consistently earn 12% a year in and out while controlling risk without having in place a solid put selling strategy and being highly selective in the stocks they sell options against.

So while many investors aim for that 2% or more every month I am content to establish a goal of 12% a year for my entire portfolio and wait for the opportunities to come to me.

Fair enough. Despite the technical points of contention I raise above, I fundamentally agree with this author about using the strategy of selling puts to create income. I focus much more on maximizing each individual trade rather than the overall portfolio. To me, if each trade is as good as I can make it, then the effects on the portfolio will take care of themselves. In addition, I exclusively sell weekly options in order to reduce the risk from extreme changes  in a stock. It reduces my per-trade return, but it increases my success level and averages out to higher returns over time.

Stock Broker – Finding the Best Stock Broker for Options Trading

In this article you will learn why you need a broker, how to find one, and how to pick the best one for your needs. Learn the questions to ask to make sure your relationship with your broker will be a long and productive one.

What a Broker Does for You

Options, just like stocks, are traded on marketplaces called exchanges. There are many throughout the country and the world. A broker, or broker-dealer, is a company that relays your buy and sell orders to the exchanges. There are lots of legal requirements of brokers, which is why there really aren’t that many of them considering the vast sums of money that go into the financial markets.

In exchange for providing this service, the broker will charge you fees on your trading. The structure of these fees can vary widely, so be sure what you are signing up for when opening a new brokerage account. Some brokers charge a flat monthly rate, others charge only when you trade (commissions). A lot of brokers have a tiered structure where their fees will change depending on how much and what kind of trading you do. As an options trader, you will be most interested in the fees for option trades and whether they are per trade, per contract, or some combination.

These days, most brokers will have some sort of online presence. Some have just websites. Others have websites and downloadable applications. Some of the more tech-savvy brokers also have mobile apps for smart phones and tablets (iPhones, iPads, androids, etc).

Trading Options on Brokerages

Because options trading is an advanced topic that is well beyond the average investor, the SEC has made it so that you have to apply for options trading privileges from your broker platform. Usually, these privileges come in different levels, with strategies the require the least leverage at the bottom and strategies that require the most leverage at the top. E*TRADE’s options tier is pretty typical:

  •  Level 1 Options Trading: Covered calls
  • Level 2 Options Trading: Synthetic longs, long calls, long puts, long straddles & strangles, covered puts
  • Level 3 Options Trading: Debit spreads, credit spreads, calendar & diagonal spreads, naked puts, butterflies & condors
  • Level 4 Options Trading: Naked calls
For the purposes of the kind of trading discussed here, you’d need to get Level 3 Options Trading if E*TRADE is your broker. Other stock brokers may call it different things, but the same principle applies. Make sure you are able to make the kinds of options strategies you want on whichever broker you choose.

Options Availability on Brokers

Surprisingly, there are still brokers out there that will not allow clients to trade options at all. Before signing up for an account, be sure to read the terms and conditions on the broker’s website. If options aren’t mentioned as a specific category of security, then move on to the next choice.
What is more common though, is brokers that only have monthly options and LEAPs available. Weekly options have been available in the market since at least 2006, yet many brokers continue to prevent clients from trading them. The brokers claim that this is because weekly options are only for professional traders, and therefore retail traders (you and me) don’t need access to them. This is a completely inane argument, but if you run into this sort of thing, move on to the next choice. Fortunately, some of the biggest brokers are coming around and opening up weekly options to all traders. This is important because selling weekly options is one of the most powerful strategies available because the time value erodes so quickly, allowing you to keep more and more of the original premium.

Which Brokerages are Best for Options Trading

What follows is a partial list of brokers. It is beyond the scope of this article to list every broker available, so I will only mention some of the larger ones as well as some of the better ones.

E*TRADE

E*TRADE is one of the largest brokers in the world. This is where your average retail investor does his buying and selling.

Fee structure: Mixed. High frequency traders (more than 150 trades per quarter) pay $7.99 per option plus $0.75 per contract. Low frequency traders (less than 150 trades per quarter) pay $9.99 per option plus $0.75 per contract.

Advantages: E*TRADE is one of the biggest brokerages in the world, with a website, downloadable applications, and mobile apps. E*TRADE does now allow weekly option trading.

Disadvantages: E*TRADE is geared towards regular retail investors. The user interface for entering options is slow and convoluted requiring many different steps. There are few tools available to the options trader, and conditional orders do not always work like you expect them to.

TD Ameritrade

Slightly more sophisticated than E*TRADE, TD Ameritrade has the other 40% of retail buyers.

Fee structure: $9.99 per option plus $0.75 per contract.

Advantages: More tools like P&L calculators for complex positions and an easier interface than E*TRADE.

Disadvantages: For low volume traders, commissions are expensive.

optionsXpress

optionsXpress is an option trader’s platform for the retail investor.

Fee structure: $1.25 per contract with a $12.95 minimum

Advantages: Built entirely for options traders. The interface and tools are very easy to use, most just require a couple clicks to place a complex order. Conditional orders are available and customizable. optionsXpress has web, PC, and mobile applications. optionsXpress also has probably the best paper trading system available to test out new strategies and ideas.

Disadvantages: For low volume traders, optionsXpress is expensive.

TradeStation

TradeStation is for serious traders who aren’t afraid to spend the time and energy involved in learning the complicated trading environment.

Fee structure: Mixed. Platform fees will vary depending on what services you subscribe to, but average around $100 per month. $1 per contract trading fees.

Advantages: TradeStation is extremely powerful and customizable with its own programming language. You can build very sophisticated positions quickly and easily. The $1 per contract commission allows for scaling in and out of positions without any troubles.

Disadvantages: Learning the desktop environment and EasyLanguage will take time and study. TradeStation is built around the desktop application. No mobile applications, and using the website is slow. Also TradeStation requires high minimum balances.

Interactive Brokers

Similar to TradeStation in level of trader, Interactive Brokers requires commitment to learn and use.

Fee structure: Mixed. Commissions vary from $0.25 per contract to $0.75 per contract ($1 minimum) depending on monthly volume and options premium. Similar to TradeStation, Interactive Brokers also charges platform fees on a monthly basis. Expect to pay anywhere from $50 and up depending upon which services you subscribe to.

Advantages: Powerful options trading tools, mobile applications, low commissions, easy worldwide trading, and customizable order types.

Disadvantages: High minimum balances.

Conclusion

The broker that is best for you will be a match for your trading style, your experience, your available capital, and your trading volume. Examine each of the brokers listed here to discover what is right for you. In the stock market there is no such thing as one size fits all.

Weekly Options Bible – Everything You Need to Know

Weekly options are options on various stocks and indices that expire every week. In principle, they work exactly the same as monthly options, but there are some differences in the way they trade that the smart put seller needs to be aware of. So in this article, I’m going to go over:

  • what weekly options are
  • how they work
  • how they are the same as monthly options
  • how they are different from monthly options
  • which securities you can trade weekly options on
  • and why they are excellent choices for selling puts.
I assume throughout this article that you are familiar with basic option concepts like puts, calls, expiration dates, and strike prices.

Weekly Option Basics

What are weekly options?

Weekly options are simply options that expire at the end of each week. On most brokerage platforms, you’ll something that says an expiration date with a “w” on the end or “wk 2″ or something similar. See the picture below for an example using the stock MSFT. Read the rest of this entry »