How to Make Passive Income with Call Option Spreads

Member

By jtreptiles
User-Submitted Article

Article Rating: (6 Ratings)

Passive Income

This article is written for the investor that is familiar with trading options and has done a few covered call or naked put options. If you are unfamiliar with these two options strategies, see my article on How to Make a Passive Income with Covered Call Options and How to Make a Passive Income with Naked Put Options. Essentially what you are doing in this strategy is selling an out of the money put and buying a further out of the money put.

Difficulty: Moderate

Instructions

Things You'll Need:

Computer with an internet connection
A brokerage account enabled with Level III Options Spread trading

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 10 percent a month.
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).
Step 3

Determine SPY’s monthly trading range. Lets say last month that SPYs high was $93.00 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 rise 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 adding 10% ($9.10...we’ll round to $9.00). This gives me a target of $100.00.
Step 4

Research SPYs out of the money Vertical Call 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

+SWGHU 99.00/100.00 .16 .22 +SWGHV
+SWGHV 100.00/101.00 .10 .18 +SWGHW
+SWGHW 101.00/102.00 .06 .16 +SWGHX
+SWGHX 102.00/103.00 .04 .14 +SWGHY
Step 5

I chose to sell 10 options contracts of +SWGHV and purchase 10 contract of +SWGHW at my strike price of $100.00. I am selling 10 contracts, and buying 10 contracts at a $1 difference, so 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 skyrockets 10% before my expiration date). 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 $160 (the current market price was .16...dont forget to multiply this by 1000!). This give me a 16% return on my money. Should the market take an unforeseen dip within the month, I can always buy back my naked call (and sell back my purchased call), 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 $1920...giving me 192% a year in passive income!