Things You'll Need:
- An online brokerage account with option trading abilities.
- A sound understanding of options and how they work.
- One hour each month.
- At least $1000 to invest.
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Step 1
Options trading is not as difficult as most people think. However, it does require a sound understanding of what options are and how to use them to your advantage. The first step you'll need to take is to learn the basics about options. There are hundreds of sites that provide great information, or just check out a book at your local library.
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Step 2
Once you understand the basics about options trading, you'll need to develop a trading strategy. There are many profitable ones, but this article will discuss one - The Iron Condor strategy. This strategy can work in either up or down markets, but is most profitable during periods of low economic fluctuation.
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Step 3
To set an iron condor in motion, you'll first need to wait for the right date. The date you will want to place your trade in the 3rd Friday of the month. This is the date that options expire. The reason you need to wait for this date is so that you'll have exactly one month to invest your money. This ensures consistency, as you will be repeating your trade on the same date each month.
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Step 4
Next, you'll need to choose what you are going to invest in. Because the iron condor strategy works best in a stable market, choosing an index fund works best. I prefer to use the S&P 500, but the strategy will work well with a number of indexes.
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Step 5
Now you'll place your trades. The iron condor strategy makes money by selling a call and a put on the same index fund. Let's say the current price of the fund is $100. You'll want to sell a call at the strike price of $120, and sell a put at a strike price of $80. For simplicity, we'll say you sell 1 of each, and that they each sold for $1 each. Upon the sale, you'll make $200 ($1 x 100 options x 2). Your hope is that the price of the index fund will never go above 120 or below 80. If it stays within that range for one month, the options you sold will expire worthless, and you will keep the $200. You've just made $200 without spending anything (except trading fees).
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Step 6
So what if the index fund goes outside of your $80 - $120 range? This is where the second part of the iron condor strategy comes into play. Because your loss potential is limitless if you sell the aforementioned call and put, you need to put some insurance policies on your sold options.
To do this, you will now buy a call at a strike price of $125 for $.80, and a put at $75 for $.80. Now, if for some reason the fund goes outside of the range of 75-125, you will only be down $.20 per option, or $200. The downside is now your $200 profit is down to $40 ($200 - ($80x2)). -
Step 7
The key is to sell your calls and puts at the right strike prices. Be conservative and you'll increase your chances of taking a gain instead of a loss. The wider your range, the safer you'll be, but you will make less money per month. But, make your range too small and you'll end up with a loss.
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Step 8
Experience has shown me that if I try to earn just 10% per month, I have a 98% chance of doing so. But, if I try to earn 20% per month, my chance of earning that amount is only about 80%.
I find that %10 profit potential is more than enough to risk, and making a 120% return each year suits me just fine! -
Step 9
In the scenario presented, I would have made $40 if things when my way. I would only have needed $360 in my account to place these trades, as that would have covered my two buys and my losses should the index fund moved out of my range. So, $360 was turned into $400 in one month. That's an 11% return, or 133% over one year. Not too shabby. (P.S. - Don't forget to factor in trading fees...)
Comments
drmark27 said
on 8/20/2009 No offense intended to the author "derekawalker," but this article is a complete joke. The main thing missing is the slight detail about what happens when this trade doesn't work. You can indeed make 10-12% per month but when you lose once every 5-10 months, the loss will be 6-10 times what you normally make in a successful month. If you're really cursed then you will try this trade and win a couple times because when you then get slammed with a loss and see months of profits down the drain, you will never want to attempt it again. Yes, you can adjust the trade to limit losses. However, in doing so you will markedly reduce your average profit per month from 10-20% to 2-4%--and you will still have losing months.
Let's be realistic here, folks. We don't say "options trading is a zero-sum game" for nothing.
brandy1123 said
on 9/6/2008 very good article