As I said in Options 102: Reading the Tea Leaves and finding the Trades, selling options can be more lucrative than buying options. However along with that comes an increased risk and also some requirements by my broker that I am not willing to take. But there is a way to sell options with minimal risk and financial outlay. That is using credit spreads.
What is a credit spread? To make it as simple as possible, the word “credit” means I get paid for initiating the spread or position. I sell one option receiving credit or money and then I buy another option as an insurance policy. The insurance policy costs less to buy than the money I took in so the difference is my net credit.
The difference between the two strike prices of the options bought and sold is $1. For every contract I engage in this strategy I have to have $100 in my account. If I want to do 5 contracts I need $500, 10 contracts $1000 and so on.
I always try to use strike prices away from the actual price of the stock which provides more safety. These are called out of the money strikes. Do not let that term confuse you as these are usually shaded a different color than the in the money strikes.
The spreads I like to do are called Bear Call Credit Spreads (BCCS) and Bull Put Credit Spreads (BPCS). I like BCCS when a stock is showing signs of retreating from an uptrend or just staying neutral. I like BPCS when the stock is in a nice solid uptrend with no sign of weakness or pullback. These are conditions when the melting ice cube effect as talked about in Option 102 work well to my advantage.
Example of options chain. Center numbers are the strike prices. The numbers on the left ate the price of calls and the number on the right are the put prices. Prices in white are the out of the money prices and the ones I am interested in.
Example of an order for 1 contract of a Bear Call Credit Spread, selling 1 February 17, 2017, 78.50 call and buying 1 February 17, 2017, 79.50 call for insurance.
This spread in this example will net me $0.31, ($0.65 – $0.34) or $31.00 per contract. Five contracts will net $155 and 10 will net $310.
A Bull Put Credit Spread is done the exact same way.
Putting It All Together
Let me putt this simple, plan for consistent income with limited risk and little time commitment into steps.
- Monday morning shortly after market opens, check the general mood of the market.
- About an hour to 2 hours after the market opens, run my search for stocks that have weekly option, sell between $50 and $150 and have their 10 day and 65 day moving averages at a 3 month high. (This is all built into my search so it’s done with 1 keystroke)
- Graph the top 5 results.
- Check which way the tail of the 5 day moving average of timing is pointing. If pointing up then I’ll look at doing a BPCS, if down a BCCS.
- Check Yahoo Earnings Calendar to make due there is no earnings reports due this week.
- Check options chain for the present week, making certain I keep my strikes out of the money.
- Making certain my net credit will be at least $0.25.
- Place order with my broker or online trading platform.
Now all I have to do is watch. If I did a BCCS, I want the price of the stock to end the week below the strike price I sold. If I did a BPCS I want the stock price to end the week above the strike price I sold. If it does there is no action required on my part, the options just expire worthless and I keep all the money I was credited upon initiation on Monday.
If the stock goes completely against me, the most I could lose in the scenario above is $0.69 or $69 per contract. Since my strike prices a $1.00 intervals $78.50 – $79.50, I have obligated myself for $100.00 per contract. I took in $31 upon initiation so my net obligation is $69 which is my total risk per contract. I also have a nice safety built in as my stock would have to go up by $1.28 before I am at risk. ($78.50 -77.22 =$1.28)
My next post in the Options series will be, Options 105; Money Management