One evening after fighter practice while we were enjoying a beer at “church”, Patrick and I were discussing income from investments.  I talked about my “selling puts” strategy, and promised him I would explain it in more detail.  I figured why not explain it here so more can benefit and comment.

I will start by saying that using options is by definition using leverage.  One option represents 100 shares. As such, gains and losses are magnified.  As well, options create “ordinary income” and you will be taxed at your full income tax rate for the gains you make (unless you do this in a 401(k) or IRA account).  This is USA tax advice, obviously varies by country.

To do the strategy I will describe, you need to have basic option functionality for your account and available margin.  Brokerage fees/commissions tend to be higher than stock transactions.

First, here are some base statistics for options.  There is an erroneous statistic that is quoted that 90% of options expire worthless.  That is actually false.  10% are exercised.  That does not mean that 90% expire worthless.

10% are exercised (in the money at expiration date, seller could have made a gain or loss)

55%-60% are closed out before expiration (could be at a gain or loss)

30-35% expired worthless (seller makes 100% gain if held to expiration)

So the ratio is still 3-1 for exercised compared to expired worthless, but the 90% “internet truth” is wrong.

I would hope before anyone trades in options that you have a basic understanding of them, but here is a simple explanation.

An option is a right to buy (call) or sell (put) a stock at a certain price (strike price) before a certain time (expiration date).  “American” style options can be exercised at any time.  Selling an option is going short the option (you hope the option goes down in price).  Buying an option is going long an option (you hope that an option goes up in value).  When you buy an option, maximum loss is your investment.  When you sell an option, you can lose much more than the price you receive.

Options have two components of value – actual value which is the actual price of the underlying security less the strike price of the option and time value which is the trading price of the option less the actual value of the option.  Time value is a complex relationship between the volatility of the underlying stock and the actual remaining time.  Valuing options is typically done via a Black-Scholes model (there are even more modern valuation methods) and there are a huge number of firms that specialize in trading differences between the market value of options and the valuation model.  In general, if you trade liquid options on stocks with good value, then the market price tends to revert to the model price because of the automated buyers and sellers.

That was a pretty long intro.  There is just too much background information on options that I could explain, but that should cover the basics.  Here is a book that can help.  I prefer Options as a Strategic Investment, but it is way more expensive.

http://www.amazon.com/Understanding-Options-2E-Michael-Sincere/dp/0071817840/ref=pd_sim_14_2?ie=UTF8&dpID=51q5Y48G6JL&dpSrc=sims&preST=_AC_UL160_SR105%2C160_&refRID=0EYQMNRN4D2J8J79SE4S

My strategy is to sell slightly out of the money Put contracts with a fairly short time to expiration date.  This a bullish to neutral strategy as you hope the stock stays the same price or goes up (or goes down less than the “slightly out of the money gap”).

Breaking it down, you need to do the following:

  • Pick a stock
  • Pick the time you want the option to be outstanding
  • Pick the strike price of the option

You also need sufficient margin in your account to support the trade.

My strategy has two built in flaws. Because you use shorter duration contracts, you will do more transactions in a year and incur higher commission expenses. Because I tend to use shorter time durations (one month to one week), there is less “time value” available.

The other basic flaw is that you can make a lot of small wins and then lose all of in in one trade if the stock moves much larger than expected downwards.  I try and reduce this risk by carefully selecting when the trade will happen, but this is the basic downside to any options trade.

  • Picking the stock

This is a leveraged, short time duration strategy. It has a slightly bullish orientation. So you need to select a stock that you have some confidence that it will at least be stable in the period you choose and it probably should be a stock that you understand well and that you would be comfortable owning. However, this is not my other selling puts strategy (backing into owning a stock that you like but is too expensive).  This is an income generating strategy.

One potential source for a stock to pick is the S&P Platinum Portfolio.  It is S&P’s “best of the best” list.  The list is not perfect, of course, but it does have a very long track record of good performance versus the market.

You can also pick an index or an ETF that tracks an index.  Many stable stocks track the market in the short term anyways, so the overall market is as good a choice as any.

Finally, you want a stock that trades pretty often and has a lot of option trades.  Otherwise spreads are quite wide and it is hard to enter into and close trades.

I personally pick AT&T.  I own the stock, follow it pretty closely, it trades a lot and options are liquid, in a disaster it pays a good dividend anyways, and it is completely a USA business so less need to worry about something happening overseas.  It is pretty stable overall so there is less time value premium.

For purposes of this example, I will also look at Apple and SPY (Vanguard S&P 500 tracking ETF).  I have included the option chains (from TD Ameritrade)  from the day I am typing this plus the current stock price and the last three months of historical prices (Yahoo Finance is great to get those).

I could be a smarter blogger and put all these tables at the end of the blog, but this is actually important. If you want to follow this type of strategy, you need to spend some time studying this type of information to get comfortable with it. If you don’t spend the time, I recommend the don’t pass line at the nearest casino with reasonable craps rules. After options commissions, “trading” without knowledge and a plan is probably not as good as the odds at the don’t pass line.

T 5 days until expiration ($33.51)

Puts  Bid Ask Last Change Vol Op Int
32.5 Put 0.04 0.05 0.04 0.00 0 626
33.0 Put 0.09 0.10 0.08 0.00 0 1,844
33.5 Put 0.22 0.23 0.20 0.00 0 1,643
34.0 Put 0.50 0.55 0.46 0.00 0 510
34.5 Put 0.78 1.02 0.89 0.00 0 126
35.0 Put 1.24 1.51 — 0.00 0 0

 

T 26 days until expiration ($33.51)

Puts  Bid Ask Last Change Vol Op Int
32.5 Put 0.17 0.20 0.17 0.00 0 3,432
33.0 Put 0.27 0.31 0.29 0.00 0 412
33.5 Put 0.45 0.49 0.43 0.00 0 516
34.0 Put 0.71 0.75 0.67 0.00 0 302
34.5 Put 1.00 1.10 0.88 0.00 0 36
35.0 Put 1.29 1.54 1.49 0.00 0 6

 

AAPL  5 days until expiration ($119.5)

Puts  Bid Ask Last Change Vol Op Int
117.0 Put 0.66 0.68 0.66 0.00 7,894 2,084
118.0 Put 0.97 1.00 0.98 0.01 6,267 3,274
119.0 Put 1.41 1.43 1.43 0.04 5,965 2,766
120.0 Put 1.92 1.98 1.92 0.00 11,584 3,860
121.0 Put 2.58 2.65 2.53 -0.05 4,205 1,327
122.0 Put 3.35 3.45 3.30 -0.05 1,158 593

 

AAPl  26 days until expiration ($119.5)

Puts  Bid Ask Last Change Vol Op Int
117.0 Put 2.06 2.12 2.06 0.00 128 426
118.0 Put 2.45 2.50 2.41 -0.03 41 135
119.0 Put 2.89 2.95 2.70 -0.19 109 92
120.0 Put 3.35 3.50 3.20 -0.15 113 137
121.0 Put 3.90 4.00 3.39 -0.51 33 86
122.0 Put 4.55 4.65 4.32 -0.23 43 58

 

SPY 5 days until expiration ($207.93)

Puts  Bid Ask Last Change Vol Op Int
206.5 Put 0.89 0.97 0.93 -0.04 9,073 11,100
207.0 Put 1.08 1.12 1.09 -0.03 18,145 15,832
207.5 Put 1.21 1.29 1.29 -0.01 7,246 5,922
208.0 Put 1.43 1.48 1.46 0.01 32,493 8,987
208.5 Put 1.61 1.70 1.77 0.07 14,330 5,232
208.8 Put 1.14 1.85 1.10 -0.73 0 56

 

SPY 26 days until expiration ($207.93)

Puts  Bid Ask Last Change Vol Op Int
206.5 Put 2.33 2.43 2.27 -0.06 314 1,680
207.0 Put 2.49 2.60 2.28 -0.21 116 1,394
207.5 Put 2.67 2.78 2.44 -0.23 303 514
208.0 Put 2.85 2.94 2.91 0.00 650 2,264
208.5 Put 3.05 3.18 3.25 0.07 370 307
208.8 Put — — 3.10 -0.15 10 41

 

T historical prices

Date Open High Low Close Volume Adj Close*
Oct 30, 2015 33.62 33.75 33.51 33.51 24,420,900 33.51
Oct 29, 2015 33.48 33.67 33.28 33.55 17,746,000 33.55
Oct 28, 2015 33.36 33.60 33.13 33.42 27,780,400 33.42
Oct 27, 2015 33.57 33.61 33.16 33.21 24,356,700 33.21
Oct 26, 2015 33.75 33.76 33.48 33.66 25,400,300 33.66
Oct 23, 2015 34.70 34.74 33.62 33.74 46,213,200 33.74
Oct 22, 2015 33.46 34.16 33.46 33.96 32,707,100 33.96
Oct 21, 2015 33.88 33.94 33.33 33.60 27,215,000 33.60
Oct 20, 2015 33.59 33.85 33.52 33.75 20,014,100 33.75
Oct 19, 2015 33.63 33.69 33.42 33.63 27,757,500 33.63
Oct 16, 2015 33.75 33.86 33.54 33.83 32,868,400 33.83
Oct 15, 2015 33.33 33.50 33.20 33.49 18,564,200 33.49
Oct 14, 2015 33.23 33.39 33.10 33.27 23,282,700 33.27
Oct 13, 2015 33.19 33.29 33.06 33.22 22,063,400 33.22
Oct 12, 2015 33.20 33.31 33.07 33.30 14,109,800 33.30
Oct 9, 2015 33.42 33.52 33.00 33.14 19,351,300 33.14
Oct 8, 2015 33.11 33.41 32.87 33.40 17,305,200 33.40
Oct 7, 2015 33.07 33.34 33.01 33.12 21,010,300 33.12
Oct 7, 2015 0.47 Dividend
Oct 6, 2015 33.50 33.52 33.25 33.31 27,867,000 32.84
Oct 5, 2015 32.98 33.49 32.97 33.43 27,876,700 32.96
Oct 2, 2015 32.34 32.64 32.19 32.64 28,505,900 32.18
Oct 1, 2015 32.48 32.64 32.17 32.53 30,815,500 32.07
Sep 30, 2015 32.36 32.71 32.24 32.58 34,815,500 32.12
Sep 29, 2015 31.99 32.18 31.85 32.07 33,785,200 31.62
Sep 28, 2015 32.26 32.34 31.88 31.90 35,924,900 31.45
Sep 25, 2015 32.27 32.70 32.16 32.33 27,104,200 31.87
Sep 24, 2015 32.02 32.23 31.95 32.11 24,741,400 31.66
Sep 23, 2015 32.29 32.34 32.04 32.20 15,739,200 31.75
Sep 22, 2015 32.32 32.45 32.13 32.27 25,518,700 31.81
Sep 21, 2015 32.55 32.69 32.45 32.56 19,870,300 32.10
Sep 18, 2015 32.68 32.79 32.41 32.55 44,627,200 32.09
Sep 17, 2015 32.73 33.14 32.41 32.78 37,922,100 32.32
Sep 16, 2015 32.86 33.10 32.76 32.94 23,514,200 32.48
Sep 15, 2015 32.68 32.93 32.54 32.86 22,371,700 32.40
Sep 14, 2015 32.74 32.78 32.51 32.55 18,504,700 32.09
Sep 11, 2015 32.73 32.78 32.56 32.72 17,626,900 32.26
Sep 10, 2015 32.77 32.84 32.55 32.75 25,602,300 32.29
Sep 9, 2015 33.40 33.50 32.72 32.78 22,559,100 32.32
Sep 8, 2015 32.95 33.19 32.81 33.14 18,851,000 32.67
Sep 4, 2015 32.68 32.78 32.35 32.56 29,318,900 32.10
Sep 3, 2015 32.97 33.24 32.92 33.04 22,833,400 32.57
Sep 2, 2015 32.97 32.97 32.50 32.82 24,093,000 32.36
Sep 1, 2015 32.60 32.79 32.16 32.32 33,048,000 31.86
Aug 31, 2015 33.20 33.28 33.01 33.20 22,286,500 32.73
Aug 28, 2015 33.34 33.45 33.10 33.29 24,154,000 32.82
Aug 27, 2015 33.01 33.49 32.82 33.44 42,589,900 32.97
Aug 26, 2015 32.36 32.85 32.01 32.69 49,631,200 32.23
Aug 25, 2015 33.11 33.11 31.77 31.80 50,674,200 31.35
Aug 24, 2015 32.18 32.69 30.97 32.37 77,231,300 31.91
Aug 21, 2015 33.70 33.95 33.38 33.38 41,636,700 32.91
Aug 20, 2015 34.17 34.46 33.95 33.95 38,363,400 33.47
Aug 19, 2015 34.30 34.50 34.07 34.36 21,139,300 33.88
Aug 18, 2015 34.16 34.43 34.12 34.35 20,538,200 33.87
Aug 17, 2015 33.96 34.23 33.90 34.23 21,050,600 33.75
Aug 14, 2015 33.91 34.05 33.78 34.05 22,759,600 33.57
Aug 13, 2015 34.01 34.17 33.79 33.81 35,521,100 33.33
Aug 12, 2015 33.86 34.07 33.45 34.02 61,974,500 33.54
Aug 11, 2015 34.60 34.96 34.57 34.65 35,402,700 34.16
Aug 10, 2015 34.30 34.78 34.20 34.78 29,179,800 34.29
Aug 7, 2015 34.11 34.26 34.04 34.21 25,627,600 33.73
Aug 6, 2015 34.55 34.59 33.95 34.24 32,734,200 33.76
Aug 5, 2015 34.79 34.83 34.51 34.57 22,837,600 34.08
Aug 4, 2015 34.79 34.80 34.50 34.58 26,249,900 34.09
Aug 3, 2015 34.95 35.02 34.50 34.66 29,677,600 34.17
Jul 31, 2015 34.94 34.99 34.72 34.74 29,880,900 34.25
Jul 30, 2015 34.86 34.89 34.68 34.80 25,958,800 34.31

 

AAPL historical prices

Date Open High Low Close Volume Adj Close*
Oct 30, 2015 120.99 121.22 119.45 119.50 48,812,000 119.50
Oct 29, 2015 118.70 120.69 118.27 120.53 50,240,800 120.53
Oct 28, 2015 116.93 119.30 116.06 119.27 85,023,300 119.27
Oct 27, 2015 115.40 116.54 113.99 114.55 57,953,600 114.55
Oct 26, 2015 118.08 118.13 114.92 115.28 66,019,500 115.28
Oct 23, 2015 116.70 119.23 116.33 119.08 59,139,600 119.08
Oct 22, 2015 114.33 115.50 114.10 115.50 41,272,700 115.50
Oct 21, 2015 114.00 115.58 113.70 113.76 41,795,200 113.76
Oct 20, 2015 111.34 114.17 110.82 113.77 48,778,800 113.77
Oct 19, 2015 110.80 111.75 110.11 111.73 29,606,100 111.73
Oct 16, 2015 111.78 112.00 110.53 111.04 38,236,300 111.04
Oct 15, 2015 110.93 112.10 110.49 111.86 37,341,000 111.86
Oct 14, 2015 111.29 111.52 109.56 110.21 44,325,600 110.21
Oct 13, 2015 110.82 112.45 110.68 111.79 32,424,000 111.79
Oct 12, 2015 112.73 112.75 111.44 111.60 30,114,400 111.60
Oct 9, 2015 110.00 112.28 109.49 112.12 52,533,800 112.12
Oct 8, 2015 110.19 110.19 108.21 109.50 61,698,500 109.50
Oct 7, 2015 111.74 111.77 109.41 110.78 46,602,600 110.78
Oct 6, 2015 110.63 111.74 109.77 111.31 48,196,800 111.31
Oct 5, 2015 109.88 111.37 109.07 110.78 51,723,100 110.78
Oct 2, 2015 108.01 111.01 107.55 110.38 57,560,400 110.38
Oct 1, 2015 109.07 109.62 107.31 109.58 63,748,000 109.58
Sep 30, 2015 110.17 111.54 108.73 110.30 66,105,000 110.30
Sep 29, 2015 112.83 113.51 107.86 109.06 73,135,900 109.06
Sep 28, 2015 113.85 114.57 112.44 112.44 51,723,900 112.44
Sep 25, 2015 116.44 116.69 114.02 114.71 55,842,200 114.71
Sep 24, 2015 113.25 115.50 112.37 115.00 49,810,600 115.00
Sep 23, 2015 113.63 114.72 113.30 114.32 35,645,700 114.32
Sep 22, 2015 113.38 114.18 112.52 113.40 49,809,000 113.40
Sep 21, 2015 113.67 115.37 113.66 115.21 46,554,300 115.21
Sep 18, 2015 112.21 114.30 111.87 113.45 73,419,000 113.45
Sep 17, 2015 115.66 116.49 113.72 113.92 63,462,700 113.92
Sep 16, 2015 116.25 116.54 115.44 116.41 36,910,000 116.41
Sep 15, 2015 115.93 116.53 114.42 116.28 43,004,100 116.28
Sep 14, 2015 116.58 116.89 114.86 115.31 58,201,900 115.31
Sep 11, 2015 111.79 114.21 111.76 114.21 49,441,800 114.21
Sep 10, 2015 110.27 113.28 109.90 112.57 62,675,200 112.57
Sep 9, 2015 113.76 114.02 109.77 110.15 84,344,400 110.15
Sep 8, 2015 111.75 112.56 110.32 112.31 54,114,200 112.31
Sep 4, 2015 108.97 110.45 108.51 109.27 49,963,900 109.27
Sep 3, 2015 112.49 112.78 110.04 110.37 52,906,400 110.37
Sep 2, 2015 110.23 112.34 109.13 112.34 61,888,800 112.34
Sep 1, 2015 110.15 111.88 107.36 107.72 76,845,900 107.72
Aug 31, 2015 112.03 114.53 112.00 112.76 56,229,300 112.76
Aug 28, 2015 112.17 113.31 111.54 113.29 53,164,400 113.29
Aug 27, 2015 112.23 113.24 110.02 112.92 84,616,100 112.92
Aug 26, 2015 107.09 109.89 105.05 109.69 96,774,600 109.69
Aug 25, 2015 111.11 111.11 103.50 103.74 103,601,600 103.74
Aug 24, 2015 94.87 108.80 92.00 103.12 162,206,300 103.12
Aug 21, 2015 110.43 111.90 105.65 105.76 128,275,500 105.76
Aug 20, 2015 114.08 114.35 111.63 112.65 68,501,600 112.65
Aug 19, 2015 116.10 116.52 114.68 115.01 47,445,700 115.01
Aug 18, 2015 116.43 117.44 116.01 116.50 34,560,700 116.50
Aug 17, 2015 116.04 117.65 115.50 117.16 40,884,700 117.16
Aug 14, 2015 114.32 116.31 114.01 115.96 42,929,500 115.96
Aug 13, 2015 116.04 116.40 114.54 115.15 48,535,800 115.15
Aug 12, 2015 112.53 115.42 109.63 115.24 101,217,500 115.24
Aug 11, 2015 117.81 118.18 113.33 113.49 97,082,800 113.49
Aug 10, 2015 116.53 119.99 116.53 119.72 54,951,600 119.72
Aug 7, 2015 114.58 116.25 114.50 115.52 38,670,400 115.52
Aug 6, 2015 115.97 116.50 114.12 115.13 52,903,000 115.13
Aug 6, 2015 0.52 Dividend
Aug 5, 2015 112.95 117.44 112.10 115.40 99,312,600 114.88
Aug 4, 2015 117.42 117.70 113.25 114.64 124,138,600 114.12
Aug 3, 2015 121.50 122.57 117.52 118.44 69,976,000 117.91
Jul 31, 2015 122.60 122.64 120.91 121.30 42,885,000 120.75
Jul 30, 2015 122.32 122.57 121.71 122.37 33,628,300 121.82

 

SPY historical prices

Date Open High Low Close Volume Adj Close*
Oct 30, 2015 209.06 209.44 207.74 207.87 125,338,300 207.87
Oct 29, 2015 208.35 209.27 208.21 208.89 84,727,800 208.89
Oct 28, 2015 207.00 208.98 206.21 208.94 132,528,000 208.94
Oct 27, 2015 206.20 207.00 205.79 206.57 74,930,600 206.57
Oct 26, 2015 207.30 207.37 206.56 206.99 66,254,500 206.99
Oct 23, 2015 207.25 207.95 206.30 207.52 138,355,700 207.52
Oct 22, 2015 202.98 205.51 201.85 205.21 164,941,500 205.21
Oct 21, 2015 203.61 203.79 201.65 201.87 99,149,500 201.87
Oct 20, 2015 202.85 203.84 202.55 203.09 75,598,000 203.09
Oct 19, 2015 202.50 203.37 202.13 203.32 73,106,800 203.32
Oct 16, 2015 202.83 203.29 201.92 203.27 109,692,900 203.27
Oct 15, 2015 200.08 202.36 199.64 202.29 125,812,600 202.29
Oct 14, 2015 200.18 200.87 198.94 199.30 95,532,400 199.30
Oct 13, 2015 200.65 202.16 200.05 200.18 83,578,000 200.18
Oct 12, 2015 201.42 201.76 200.91 201.59 55,425,200 201.59
Oct 9, 2015 201.38 201.90 200.58 201.40 94,899,000 201.40
Oct 8, 2015 199.41 201.55 198.59 201.20 148,387,100 201.20
Oct 7, 2015 198.90 199.83 197.48 199.43 120,246,700 199.43
Oct 6, 2015 198.31 198.98 197.00 197.81 106,144,200 197.81
Oct 5, 2015 196.46 198.74 196.33 198.48 122,213,200 198.48
Oct 2, 2015 189.77 195.03 189.12 194.99 206,129,500 194.99
Oct 1, 2015 192.08 192.49 189.82 192.16 127,828,700 192.16
Sep 30, 2015 190.37 191.83 189.44 191.59 152,593,200 191.59
Sep 29, 2015 188.27 189.74 186.93 188.08 152,279,900 188.08
Sep 28, 2015 191.78 191.91 187.64 187.91 158,514,500 187.91
Sep 25, 2015 194.64 195.00 191.81 192.87 142,052,900 192.87
Sep 24, 2015 192.15 193.45 190.56 192.93 159,378,800 192.93
Sep 23, 2015 194.11 194.67 192.91 193.60 92,790,600 193.60
Sep 22, 2015 193.88 194.46 192.56 193.90 153,890,900 193.90
Sep 21, 2015 196.44 197.68 195.21 196.44 105,726,200 196.44
Sep 18, 2015 195.71 198.68 194.96 195.36 223,657,500 195.36
Sep 18, 2015 1.033 Dividend
Sep 17, 2015 200.02 202.89 199.28 199.70 276,046,600 198.67
Sep 16, 2015 198.82 200.41 198.41 200.14 99,581,600 199.10
Sep 15, 2015 196.61 198.99 195.96 198.45 113,806,200 197.42
Sep 14, 2015 196.95 197.01 195.43 195.98 79,452,000 194.97
Sep 11, 2015 195.38 196.82 194.53 196.81 119,691,200 195.79
Sep 10, 2015 194.56 197.22 194.25 195.85 158,611,100 194.84
Sep 9, 2015 199.32 199.47 194.35 194.76 149,347,700 193.75
Sep 8, 2015 195.94 197.61 195.17 197.46 116,025,700 196.44
Sep 4, 2015 192.85 193.86 191.61 192.59 207,081,000 191.59
Sep 3, 2015 196.26 198.05 194.96 195.65 152,087,800 194.64
Sep 2, 2015 194.62 195.46 191.77 195.36 160,269,300 194.35
Sep 1, 2015 193.12 194.77 190.73 191.92 256,000,400 190.93
Aug 31, 2015 198.11 199.13 197.01 197.54 163,298,800 196.52
Aug 28, 2015 198.50 199.84 197.92 199.24 160,414,400 198.21
Aug 27, 2015 197.02 199.42 195.21 199.16 274,143,900 198.13
Aug 26, 2015 192.08 194.79 188.37 194.68 339,257,000 193.67
Aug 25, 2015 195.43 195.45 186.92 187.23 369,833,100 186.26
Aug 24, 2015 197.63 197.63 182.40 189.55 507,244,300 188.57
Aug 21, 2015 201.73 203.94 197.52 197.63 346,588,500 196.61
Aug 20, 2015 206.51 208.29 203.90 204.01 194,327,900 202.95
Aug 19, 2015 209.09 210.01 207.35 208.28 167,316,300 207.20
Aug 18, 2015 210.26 210.68 209.70 209.93 71,692,700 208.84
Aug 17, 2015 208.71 210.59 208.16 210.56 79,072,600 209.47
Aug 14, 2015 208.43 209.51 208.26 209.36 72,786,500 208.28
Aug 13, 2015 208.73 209.55 208.01 208.70 89,383,300 207.62
Aug 12, 2015 207.11 209.14 205.36 208.83 168,996,000 207.75
Aug 11, 2015 208.97 209.47 207.76 208.66 126,081,400 207.58
Aug 10, 2015 209.28 210.67 209.28 210.63 80,270,700 209.54
Aug 7, 2015 208.16 208.34 206.87 207.92 117,858,000 206.84
Aug 6, 2015 210.29 210.42 207.65 208.35 116,030,800 207.27
Aug 5, 2015 210.45 211.31 209.73 210.10 85,786,800 209.01
Aug 4, 2015 209.70 210.25 208.80 209.32 81,820,800 208.24
Aug 3, 2015 210.46 210.53 208.65 209.73 113,965,700 208.65
Jul 31, 2015 211.42 211.45 210.16 210.45 103,266,900 209.36
Jul 30, 2015 210.16 211.02 209.42 210.82 91,304,400 209.73

 

That was a lot of numbers ….

You should be looking over the numbers for ranges that have happened in the prior year in one month and one week buckets.  Of course, past performance does not guarantee future performance, but it often gives you a good clue.

What is my conclusion?  Apple seems to swing around a lot more than the options premium would justify. I don’t think just out of the money puts make sense, you would have to go to much more out of the money options to balance the risk of the stock movements.  The stock trades high volume and the options and pretty liquid as well. If you are a big Apple fan and follow them closely, it might work.

AT&T moves in a much tighter range in weekly and monthly buckets. Premiums are small but volatility is small as well.  This is the stock that I use to trade my strategy. Because the weekly profits are small, it is harder to recover if there is a week where the trade swings against you. The main advantage for me is that it pays a good dividend so if I cannot close a trade and get put I do not mind owning the stock.

SPY is also good. Much more of a swing than AT&T as the general market had some large up and down days in the period being reviewed. This is instructive as it reminds you that you can have a quick and bad day at any time. Stops help some but do not help much when there is a flash crash. That is why it is important to pick a stock that I you are put you do not mind owning.

So three stocks and any of the three could work, it depends on your personality and emotional ability to handle price changes.  You cannot make money every week or month, you need to accept and cut losses and roll over to the next period. Over time, with the right focus, you should be able to make a profit more often than you make losses (which tend to be fewer but larger).

  • Pick the period

The longer the period you pick, the more time value you receive and the more time for a temporary change in trading to revert back to the expected pattern.  However, it also is more time for the entire market to change direction or some external event to change a stock price (of course, longer dated options do give more time to recover).

I have traded one month, two month and one week options with this strategy. All worked.  For AT&T I prefer 1 week options, but 1 month work well too. When I tried Apple, I tried 2 month options as the stock was up and down more but the overall trend was flat to up so the longer term options gave more time for the strategy to work.  I found the price swings too much and there was too much non-company news that moved the stock and too many “event” days so I stopped trying to use this trade with Apple.

The other very important strategy is to avoid “story” weeks. When a stock goes ex-dividend the stock often reacts more than just the dividend. Earnings releases should also be avoided with this strategy. There is extra volatility those weeks which are good for options pricing, but they are also weeks that do not follow the pattern and the trading that you are attempting. They can be traded, but not via the strategy I am explaining here. Avoid them.

  • Pick the option

You want options that are out of the money so if the stock is flat through your period the trade works. That allows for upwards or flat movement to be a winner. You need to look at typical stock moves for the stock you picked and make sure the average down move will not cause such a large loss that it wipes out the gains you had made before.

For AT&T I have been trading weekly options and the option closest to the actual share price that is in the money. For monthly options I pick options that are deeper in the money but still give me more return than the weekly options.  For AT&T I switched to weekly options mainly because the premiums for deeper in the money longer term options did not give me the return I wanted considering the extra time used for each trade.

My results

I trade 30 AT&T options a week for about $400 – $500 a week of option premium. That is about $24K to $26K of potential income.  I have averaged $20K a year for the last several years doing it. If you get put you need about $100K to buy the shares (margin). I can trade a lot more options but my schedule often means I cannot monitor the price all day (especially when I am in China) so I am often “naked” on the close day and just need to accept being put because the stock is too close to close the trade.

Most people that do not trade on margin have enough margin available for this strategy and you can make much more than the smaller number I said above.

Options as a Strategic Investment