More investors are dipping their toes into the options market.
Last Friday over $2 TRILLION of option contracts expired, an incredible volume.
Personally I wanted to challenge myself in August and see if I could make $10K in net premiums.
It turned out to be a lot of fun! And more importantly, I learned how to make better decisions with my money.
In today’s post I’ll share the important lessons I’ve learned and offer some essential points that every beginner option trader should know. 🙂
Breaking down $10K in net option premiums
The primary strategies I used this month were bear call spreads and bull put spreads.
These are both somewhat market neutral strategies that are very lucrative in a sideways stock market.
For example, one trade alone on BBBY produced over US $500 in profit.
That trade along with all my other options transactions can be found here.
It was painful to realize I had paid $435 in trading commission this month to IBKR.
But I suppose that’s just the cost of trading options these days.
My discount brokerage must really love what I’m doing. 😂
With more capital comes more earnings potential
Making money from options require capital. And the more you have the more you can potentially make on a risk adjusted basis.
This is why I borrowed $100,000 this month to fund my brokerage account.
With this new capital I was able to increase my net premiums, leading to an all-time high in options earnings.
A huge mistake I made in February to April of this year was selling naked put options without protective legs. The income was good as you can see from the chart above. But it was not sustainable and I was only setting myself up for disaster which came in May when I had my first monthly loss!
However, since then I have learned to use more effective options strategies to reduce systemic risk.
For example, one change that I have made was reduce the duration of my overall options portfolio. Similar to how short duration bonds have lower risk to interest rate changes, short term options are easier to manage and often face less risk.
In fact, most contracts I’ve been selling lately have been weekly options.
That’s because I’ve developed a new strategy that uses weekly expirations to maximize profitability.
I haven’t told anyone about this strategy yet but…
The secret is to take advantage of company earnings!
The basic idea is to sell options when implied volatility is at the highest point. Then buy back the options for a profit after the company reports earnings.
To see how this works in the real world I have recorded myself last week placing live trades using this time sensitive strategy.
You can watch the video here, (or see below this post) where I break down 9 trades and explain what I’m doing, why I’m doing it, and how to maximize profit while managing risk.
The recording took 5 days to prepare because I wanted to share the entire weekly process instead of just a single trading session. I hope you’re able to learn something useful from my examples. 🙂
Important lessons I learned this month
In last month’s options update I wrote that I have learned to focus on shorter duration strategies and to sprinkle more call options into my portfolio. Those changes really helped improve my performance this month.
Here are some new insights that I’ve discovered more recently.
1. A little planning goes a long way
I have recently been planning out which companies I would trade options on for the following week. I can write down on a piece of the paper the tickers, as well as any option strategies I want to use.
I may be reading about one stock I like, and come across some information about another company that may be a good options candidate. So I’ll write it down on the paper and pursue the idea further next week.
This doesn’t take a lot of time to do. But it’s super useful because it prepares a framework for me to prioritize. I can explore the best ideas I have, curated from the previous week, instead of frantically looking for option trading opportunities on the fly.
2. Be willing to change the narrative
Another important lesson is to not try and force my own story or bias on the market.
I used to get upset when a stock’s price moves against my options trade. “Why aren’t you doing what I want you to do?” Sticking with a losing trade could result in more losses. So I have learned that the market doesn’t care about my trade. It does whatever it wants. And if my calculated bet is wrong, then it’s me who needs to make a change to sentiment or reasoning.
Instead of holding onto bad trades, I’ve learned to cut my losses and look for new asymmetric opportunities. I still feel bad about losing money on a trade. But it bothers me less when I realize that it’s the cumulative result over the long run that counts. This means I focus on the quality of my research to improve my odds, and I don’t judge the results of any individual trades. I look at a series of similar trades instead for better perspective.
3. There’s more than one way to profit
Options can be used to indirectly exploit meme stocks while controlling for risk. I made $1,000 in August from Bed Bath & Beyond options. As you may have heard, this is a meme stock that gained a lot of attention last week. A college student made a $110 million profit from trading the stock, BBBY. He had financing from a rich uncle, but still generated a very high ROI.
The problem with investing in meme stocks is they are very volatile and you can lose a lot of money very quickly.
The odds of a stock going up or down is 50/50 short term. There’s no edge here for most investors.
So what I’ve done instead is use options to create a cushion between the market price of BBBY stock and my strike price. I made 3 trades with BBBY options last week, and all were profitable. Here’s an example of one of them.
What happened here was when the shares were trading at about $25, I sold a $35 call option.
This gave me a $10 margin of safety where the option would not be assigned unless the stock moves from $25 to $35. I gave myself a stop loss at $400, but could make $1,000 or more if the stock fell lower. Risking $400 to make $1,000 is a reasonable bet that I was comfortable making. And these kinds of favourable risk to reward opportunities are abundant in the options market. 😉
The $10,036 I earned this month only represents the cash flow from buying and selling options. But option prices will fluctuate similar to stocks. So as long as I have an open position my portfolio could experience a mark-to-market loss.
So here’s a look at all the option contracts I currently hold as of right now.
Adding up just the “unrealized losses” from the right column, I am down $650 so far from my losing trades.
If we subtract this loss from my net proceeds we see that I have actually made $9,386 in August.
The reason why I had such poor returns in May this year was because I had built up a lot of bad trades in prior months. I was sitting on over $10,000 of unrealized losses that was not represented in my transactions. I closed most of those losing positions in May and finally realized those losses.
I have learned my lesson the hard way, and as you can see, have a much healthier portfolio of options now. 🙂
Making money is about maximizing returns while managing risk.
Both are important, and both can be improved upon with practice and experience.
August isn’t over yet. But I’m going to take this last week of the month to reflect & review my recent activities.
I want to dissect and understand which strategies worked, which didn’t, and why.
Then in September I will continue to sell options and earn premiums. I don’t know if I can replicate this month’s earnings and come up with another $10,000. But I would be happy if I can make at least $5,000 per month for the rest of this year. And then maybe $8,000 per month on average for next year in 2023. And probably even more in the future.
As I mentioned last week, making money is simply a matter of resourcefulness. As I aim to be more resourceful with my time and money, my income should grow as well. 😀
This is why I think every investor should consider an options strategy to complement their existing stock portfolio. Trading options is a skill that can be learned and improved upon with practice.
There are conservative Theta strategies to make small profits over time. These are great to learn for beginners. Instead of trying to predict if a stock will go up or down, you simply aim to collect money as time goes by.
It’s a simple strategy I used a lot when I was first learning about options.
You can see a detailed explanation of how that works in this video.
Feel free to ask any questions below, or reach out to me with any comments you have. 🙂
Thanks for reading, and good luck with your investments!
Random Useless Fact:
Housing affordability has fallen to the lowest level since the great recession.