Global Economic Intersection
Advertisement
  • Home
  • Economics
  • Finance
  • Politics
  • Investments
    • Invest in Amazon $250
  • Cryptocurrency
    • Best Bitcoin Accounts
    • Bitcoin Robot
      • Quantum AI
      • Bitcoin Era
      • Bitcoin Aussie System
      • Bitcoin Profit
      • Bitcoin Code
      • eKrona Cryptocurrency
      • Bitcoin Up
      • Bitcoin Prime
      • Yuan Pay Group
      • Immediate Profit
      • BitIQ
      • BitQH
      • Bitcoin Loophole
      • Crypto Boom
      • Bitcoin Treasure
      • Bitcoin Lucro
      • Bitcoin System
      • Oil Profit
      • The News Spy
      • Bitcoin Buyer
      • Bitcoin Inform
      • Immediate Edge
      • Bitcoin Evolution
      • Cryptohopper
      • Ethereum Trader
      • BitQL
      • Quantum Code
      • Bitcoin Revolution
      • British Trade Platform
      • British Bitcoin Profit
    • Bitcoin Reddit
    • Celebrities
      • Dr. Chris Brown Bitcoin
      • Teeka Tiwari Bitcoin
      • Russell Brand Bitcoin
      • Holly Willoughby Bitcoin
No Result
View All Result
  • Home
  • Economics
  • Finance
  • Politics
  • Investments
    • Invest in Amazon $250
  • Cryptocurrency
    • Best Bitcoin Accounts
    • Bitcoin Robot
      • Quantum AI
      • Bitcoin Era
      • Bitcoin Aussie System
      • Bitcoin Profit
      • Bitcoin Code
      • eKrona Cryptocurrency
      • Bitcoin Up
      • Bitcoin Prime
      • Yuan Pay Group
      • Immediate Profit
      • BitIQ
      • BitQH
      • Bitcoin Loophole
      • Crypto Boom
      • Bitcoin Treasure
      • Bitcoin Lucro
      • Bitcoin System
      • Oil Profit
      • The News Spy
      • Bitcoin Buyer
      • Bitcoin Inform
      • Immediate Edge
      • Bitcoin Evolution
      • Cryptohopper
      • Ethereum Trader
      • BitQL
      • Quantum Code
      • Bitcoin Revolution
      • British Trade Platform
      • British Bitcoin Profit
    • Bitcoin Reddit
    • Celebrities
      • Dr. Chris Brown Bitcoin
      • Teeka Tiwari Bitcoin
      • Russell Brand Bitcoin
      • Holly Willoughby Bitcoin
No Result
View All Result
Global Economic Intersection
No Result
View All Result

Options as Income Generators

admin by admin
February 21, 2014
in Uncategorized
0
0
SHARES
0
VIEWS
Share on FacebookShare on Twitter

Online Trading Academy Article of the Week

by Russ Allen, Online Trading Academy Instructor

One of the greatest things about options is that they can be used for so many different purposes. One of those is to generate income in a relatively conservative manner. That may not be exciting compared to some other modes of trading. But how excited do we really want to be about our IRA money? Even (sane) professional day traders don’t day trade their entire net worth.

Some option strategies are commonly used for generating income. The best known is the covered call, where an investor sells out-of-the-money call options on stocks he/she owns. Another is the Collar spread or collared stock, which adds protective puts to the covered call. Also popular but less widely practiced is the cash-secured short put. That the short put is a close cousin to the covered call is not widely understood, but in fact the two are very similar in risk and reward, when the same strike is selected.

This brings up a related point: aside from the covered calls, collars and short puts, several other option strategies that sell time value can be used as conservative income generators, when “tuned” for that task. This includes some strategies that are not normally thought of in this light. Here are some of the major ones:

  • Debit vertical spreads
  • Credit vertical spreads
  • Iron Condors
  • Double Calendars

All of these can be configured, based on strike selection, as limited-risk strategies that initially sell more time value than they buy – they are net short time value. The profit comes from the decay of the time value in the sold options, at a faster rate than that of the purchased options. The sold options are the anchors of these positions – the ones where the money is made. The idea is to sell those options short and watch their value disappear. The purchased options are for protection.

All of the above strategies can be used in an aggressive manner for short-term trading. How can we tune them for more conservative use?

By selecting strike prices for the short options that have a very low probability of finishing in the money. As long as those short options expire worthless, we’re in good shape. We approach this in two ways. Most importantly, we want to make sure that the strike price for our short options is on the other side of a high-quality supply or demand zone. Identifying these supply and demand zones is a skill that is taught in all of our trading classes. The basic idea is to locate a price level that was the origin of a sharp rally or drop in price, on the appropriate time scale. For the trades of the scale we need to use for this purpose, the proper scale is daily or weekly charts.

Secondarily, the strike prices we choose should be far enough away from the current stock price that it is statistically unlikely to be reached.

Most option trading platforms have some form of a probability calculator. This takes as inputs the current stock price; number of days to expiration; a volatility estimate; and two target prices. It then gives the probabilities of the underlying price being below, in, or above the range between the two targets at expiration. If your platform doesn’t have such a calculator, there is a rudimentary free one in excel form here: Probability of a Successful Option Trade.

The one I use is the one in my trading platform, which is from Tradestation. Here’s an example.

On February 12, 2014, the Russell 2000 exchange-traded fund (IWM) was at $112.47. IWM, along with the rest of the market, has been in an uptrend since the market bottom in 2009. There was good demand (support) under this price at the 107-109 level. IWM’s implied volatility was quite high at 18%, compared to the historical volatility, which has ranged from 8-21% over the last year. This provided an opportunity for an income-generating trade based on selling puts below the $107 level. One alternative would have been simply to sell the March 107 puts, at $.97. This would have provided a return of $.97 per $107 invested for the 37 days, which works out to a 9% annualized rate of return.

What were the chances of making money on this trade?

First, we have to calculate at what price we would break even. The probability of profit then would be the probability of IWM finishing above that break-even level at the expiration date, 37 days away.

For puts, the formula for the break-even price is the strike price less the credit. Here that is ($107.00 – $.97), or $106.03. If IWM finished at that price or higher, we would make a profit. Below that, we would have a loss. Our loss was potentially unlimited.

The probability calculator yielded these results:

Click to enlarge

The probability of IWM finishing below 106.03 (the “lower target”) in 37 days was calculated at 15.18%. That means, of course that the probability of not finishing below that level was 100% – 15.18% = 84.82%. So that indicated a probability of about 85% of breaking even or better.

As the “upper target” for the calculation, I used the $107 put strike price. If IWM finished above that level, we would make the maximum profit on this trade, with the puts expiring worthless. The indicated probability was 80.78%.

So according to the probability calculator, this trade had an 81% chance of making the maximum profit, and an 85% chance of breaking even or better.

Our 107 put strike appeared both statistically and technically sound. The only fly in the ointment was that potentially unlimited loss.

To address this, we could have done a couple of different things. First, we could have sold puts at a lower strike price. The 103 puts, below the next support level, could be sold for $.50, returning an annualized 4.8%. Their probabilities for maximum profit and for breakeven or better were 94% and 99%, respectively. The probability of loss was very small, but still real. In a disastrous downturn, our maximum loss was still technically unlimited.

If we wanted to be even safer, we could have turned this into a different strategy – a bull put spread. Using the 103 puts as the short side (selling these at $.50), we could have bought the 98-strike puts for $.24. This left a net credit of just $.26. Although buying this “insurance put” reduced our maximum profit, it also dramatically reduced our risk, as well as our capital requirement. With the 98-103 put spread, our maximum loss was cut from unlimited to $4.76. Like any credit vertical spread, the maximum loss is the spread between the strikes (103 – 98 = $5), less the net credit (.$26). Since this maximum risk would also be our margin requirement, our return of $.26 was now on an investment of $4.76. This works out to an annualized rate of return of over 50%. The probabilities for maximum profit and for break-even or better were still 94% and 99%, respectively, but with a higher rate of return.

Note that the increased return and decreased dollar risk on the bull put spread vs the short put is not completely free. It was still possible that we could lose that $4.76. That would occur if IWM did finish below $98 in March, and we held on all the way down. The probability calculator indicated a probability of IWM finishing below 98 at .81%. Unlikely but not impossible. With the short put, we would have the option to allow IWM to be put to us at the 103 strike, and hold on to it waiting/hoping for it to recover. With the bull put spread, we have no such option.

In summary, we can use multiple strategies to generate income in a manner that has a low probability of loss. With judicious selection of strike prices and attention to probabilities, we can tune our strategies to produce a combination of risk and return with which we are comfortable.


 

Previous Post

Investing.com Technical Summary 20 February 2014

Next Post

What We Read Today 21 February 2014

Related Posts

Weaker Dollar Keeps Bitcoin Above $30K As Analysts Target 60% BTC Dominance
Economics

Weaker Dollar Keeps Bitcoin Above $30K As Analysts Target 60% BTC Dominance

by John Wanguba
May 20, 2022
Ethereum Developers Tip The Merge Might Happen In August ‘If All Goes As Planned’
Business

Ethereum Developers Tip The Merge Might Happen In August ‘If All Goes As Planned’

by John Wanguba
May 20, 2022
Commonwealth Bank Puts Crypto Trading Test On Ice As Regulators Hesitate
Business

Commonwealth Bank Puts Crypto Trading Test On Ice As Regulators Hesitate

by John Wanguba
May 20, 2022
Musk Hints He Could Reprice Twitter Deal As He Looks At Fake Accounts
Business

Musk Hints He Could Reprice Twitter Deal As He Looks At Fake Accounts

by John Wanguba
May 18, 2022
Madonna Joins Hands With Digital Artist “Beeple” To Launch New NFTs
Business

Madonna Joins Hands With Digital Artist “Beeple” To Launch New NFTs

by John Wanguba
May 18, 2022
Next Post

What We Read Today 21 February 2014

Leave a Reply Cancel reply

Your email address will not be published. Required fields are marked *

Browse by Category

  • Business
  • Econ Intersect News
  • Economics
  • Finance
  • Politics
  • Uncategorized

Browse by Tags

adoption altcoins banking Binance Bitcoin Bitcoin adoption Bitcoin market Bitcoin mining blockchain BTC business Coinbase crypto crypto adoption cryptocurrency crypto exchange crypto market crypto regulation decentralized finance DeFi digital assets Elon Musk ETH Ethereum Ethereum blockchain finance funding government investment market analysis Metaverse mining NFT NFT marketplace NFTs nonfungible tokens nonfungible tokens (NFTs) price analysis regulation Russia social media technology Tesla the US Twitter

Archives

  • May 2022
  • April 2022
  • March 2022
  • February 2022
  • January 2022
  • December 2021
  • November 2021
  • October 2021
  • September 2021
  • August 2021
  • July 2021
  • June 2021
  • May 2021
  • April 2021
  • March 2021
  • February 2021
  • January 2021
  • December 2020
  • November 2020
  • October 2020
  • September 2020
  • August 2020
  • July 2020
  • June 2020
  • May 2020
  • April 2020
  • March 2020
  • February 2020
  • January 2020
  • December 2019
  • November 2019
  • October 2019
  • September 2019
  • August 2019
  • July 2019
  • June 2019
  • May 2019
  • April 2019
  • March 2019
  • February 2019
  • January 2019
  • December 2018
  • November 2018
  • October 2018
  • September 2018
  • August 2018
  • July 2018
  • June 2018
  • May 2018
  • April 2018
  • March 2018
  • February 2018
  • January 2018
  • December 2017
  • November 2017
  • October 2017
  • September 2017
  • August 2017
  • July 2017
  • June 2017
  • May 2017
  • April 2017
  • March 2017
  • February 2017
  • January 2017
  • December 2016
  • November 2016
  • October 2016
  • September 2016
  • August 2016
  • July 2016
  • June 2016
  • May 2016
  • April 2016
  • March 2016
  • February 2016
  • January 2016
  • December 2015
  • November 2015
  • October 2015
  • September 2015
  • August 2015
  • July 2015
  • June 2015
  • May 2015
  • April 2015
  • March 2015
  • February 2015
  • January 2015
  • December 2014
  • November 2014
  • October 2014
  • September 2014
  • August 2014
  • July 2014
  • June 2014
  • May 2014
  • April 2014
  • March 2014
  • February 2014
  • January 2014
  • December 2013
  • November 2013
  • October 2013
  • September 2013
  • August 2013
  • July 2013
  • June 2013
  • May 2013
  • April 2013
  • March 2013
  • February 2013
  • January 2013
  • December 2012
  • November 2012
  • October 2012
  • September 2012
  • August 2012
  • July 2012
  • June 2012
  • May 2012
  • April 2012
  • March 2012
  • February 2012
  • January 2012
  • December 2011
  • November 2011
  • October 2011
  • September 2011
  • August 2011
  • July 2011
  • June 2011
  • May 2011
  • April 2011
  • March 2011
  • February 2011
  • January 2011
  • December 2010
  • August 2010
  • August 2009

Categories

  • Business
  • Econ Intersect News
  • Economics
  • Finance
  • Politics
  • Uncategorized
Global Economic Intersection

After nearly 11 years of 24/7/365 operation, Global Economic Intersection co-founders Steven Hansen and John Lounsbury are retiring. The new owner, a global media company in London, is in the process of completing the set-up of Global Economic Intersection files in their system and publishing platform. The official website ownership transfer took place on 24 August.

Categories

  • Business
  • Econ Intersect News
  • Economics
  • Finance
  • Politics
  • Uncategorized

Recent Posts

  • Weaker Dollar Keeps Bitcoin Above $30K As Analysts Target 60% BTC Dominance
  • Ethereum Developers Tip The Merge Might Happen In August ‘If All Goes As Planned’
  • Commonwealth Bank Puts Crypto Trading Test On Ice As Regulators Hesitate

© Copyright 2021 EconIntersect - Economic news, analysis and opinion.

No Result
View All Result
  • Home
  • Contact Us
  • Bitcoin Robot
    • Bitcoin Profit
    • Bitcoin Code
    • Quantum AI
    • eKrona Cryptocurrency
    • Bitcoin Up
    • Bitcoin Prime
    • Yuan Pay Group
    • Immediate Profit
    • BitIQ
    • Bitcoin Loophole
    • Crypto Boom
    • Bitcoin Era
    • Bitcoin Treasure
    • Bitcoin Lucro
    • Bitcoin System
    • Oil Profit
    • The News Spy
    • British Bitcoin Profit
    • Bitcoin Trader
  • Bitcoin Reddit

© Copyright 2021 EconIntersect - Economic news, analysis and opinion.

en English
ar Arabicbg Bulgarianda Danishnl Dutchen Englishfi Finnishfr Frenchde Germanel Greekit Italianja Japaneselv Latvianno Norwegianpl Polishpt Portuguesero Romanianes Spanishsv Swedish