Things You'll Need:
- Computer with an internet connection
- A brokerage account enabled with Level III Options Spread trading
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Step 1
Ensure that your brokerage account allows you to conduct Level III options trading (or it may be entitled “Spreads). Depending on your broker, this is a three or four day turnaround to become certified to do this. Additionally, most brokerages want you to have an open margin account in order to trade options spreads. Your broker will ask several questions to determine if trading options spreads is suitable for you. A key fact to note is that the you should list your investment objectives as “speculative.” Do not let this term scare you away...I am going to show you a very conservative method that I have used to repeatedly make an average return of 14 percent a month.
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Step 2
Use a broad market index ETF such as SPY, DIA, QQQQ, or IWM. Pick whichever ETF that you are the most comfortable with. For this example, we will use SPY (that follows the S&P 500 index).
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Step 3
Determine SPY’s monthly trading range. Lets say last month that SPYs high was $94.00 and its low was $86.00. Now lets say that it is currently trading at $91.00. Judging by current market conditions, I would feel very comfortable saying that within the next month, I don’t believe that the S&P 500 index is going to lose 10%. After I have determined the amount of risk that I am willing to take, I do my calculation by taking the current price of SPY ($91.00) and subtracting 10% ($9.10...we’ll round to $9.00). This gives me a target of $82.00.
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Step 4
Research out of the money SPYs Vertical Put Spreads for the next month (so if it is July, research the returns in August). You will see a list of numbers that look something like this:
Symbol Strike Low High Symbol
+SZCTC 81.00/80.00 .09 .13 +SZCTB
+SZCTD 82.00/81.00 .11 .15 +SZCTC
+SZCTE 83.00/82.00 .13 .18 +SZCTD
+SZCTF 84.00/83.00 .15 .19 +SZCTE
These are the spreads. What that means is that is the difference between two options. If I executed an options spread for +SZCTE and +SZCTD I would stand to make between $13 and $18 per contract. -
Step 5
In this case however, my target price is $82.00. I chose to sell 10 options contracts of +SZCTD and purchase 10 contracts of +SZCTC. Because I am selling 10 contracts, and buying 10 contracts at a $1 difference, my account buying power will be subtracted by $1000 (because I can lose up to $1000 in this transaction if my option expires in the money. This will only happen if SPY plummets 10% in this month). Just like selling a covered call or a naked put, my account is credited with the funds immediately for a market order. In this instance, I have $1000.00 in short options and my account was credited with $140...a 14% return on my money. Should the market take an unforeseen dip within the month, I can always buy back my naked put (and sell back my purchased put), but this will cut into profit, and possibly cost money. To avoid this circumstance it is very important that your research (step #3) is solid and accurate. Now all that I have to do is wait for my options to expire next month, and then turn around and repeat the process. If I continue to just invest the original $1000 in this same way, I will make an annual profit of $1680...giving me 168% a year in passive income!
Comments
meowysmiling said
on 9/9/2009 Never heard of this,great write : )
jrofosho1 said
on 7/26/2009 Good writing 5* article