Boost Your Investing Income With These 4 Trades
Use these four trades to start earning bonus income on top of what you already earn from your dividend stocks. Even slightly increasing your income will help you take charge of your future and guarantee yourself a prosperous retirement.
For anyone interested in learning options, the SPDR S&P 500 ETF (NYSE:SPY) is a good underlying equity to start with. This ETF has some of the most liquid options in the market at the moment, meaning that you can safely trade its options without having to worry about large bid-ask spreads or putting in limit order after limit order in your search for the optimal deal. Nevertheless, most traders enter the SPY options market using the most basic options strategies (buying calls and puts, which are usually sold at a premium) only to find themselves in the red at the end of the day/week/month.
Today, we are going to look at four strategies for trading options on the SPY. I am going to give you four huge strategies – one for each type of market trend. Together, these four strategies can form the main components of your toolbox for trading or investing in the SPY.
Let’s get started:
#1 Downward Movement with a Price Target
Many emerging pieces of information, including Soros’s bearish outlook on the market, the reduced probability for a rate hike, and capital inflows to bear market hedges (e.g., gold, silver, the Yen, and bitcoin) have got investors speculating that the market might take a tumble. The last market correction can give us an idea of where the market will end up should such an event occur. Take a look at the chart below of the last market correction:
Most corrections have a logical bottom. At some point, investors come in and start buying up the stocks that have fallen, assuming that the stocks are now undervalued. This forms a bottom and often sends the market into a rebound.
The benefit of this phenomenon is that it allows us to set a price target should we assume a coming market correction. When we have a price target, we can engage in what is called a bear debit spread. In the following example, I’m going to be a bit more optimistic and assume that our price target is the incredibly strong resistance level that we see in the chart above – the green line at around $205:
Here, we sell a put with strike price a little under our price target, an August 204 put. At the same time, we buy a put option of the same expiration date that is in the money (ITM) – one with a strike price above the current price of the SPY.
By buying the 214 put and selling the 204 put, we find that the theta values offset one another, allowing us to avoid the time decay that causes many investors to lose money when they only buy puts. This means we do not need to worry about hitting our price target quickly (we have till August in the above example). In the above strategy, we are looking at 200% ROI if we hit our price target, which is a great payoff for simply assuming that the SPY will not exceed the support level.
#2 Expecting a Sudden Upward Movement
Worries of a market correction aside, we should remember that the stock market almost always moves upward, not downward. In this case, the better play is to take a long position. But most novice options players simply buy call options, again exposing themselves to time decay.
If you’re expecting good news in the market or a rebound after a market correction, the ratio backspread is a great strategy. It allows us to be long on the SPY and on volatility. That is, we benefit not only when the SPY moves upward but also when the SPY starts trading erratically on news, which can even lead to profits if the SPY moves downward.
In a ratio backspread, we sell 1 call while buying 2 or more calls with a later expiration date and higher strike price. The sold call allows us to reduce time decay, but because it is outnumbered by long calls, its bearish position is overridden and converted to a bullish position. Here is an example:
Here, we buy 4 December 220 calls while selling 1 September 200 call. The cost is quite low here, only costing us $150 to essentially mimic holding 50 shares of the SPY (this would normally cost over $10,000). But more importantly, we are long vega: We can expect to gain $173 in profit for every 1% increase in the SPY’s volatility.
Being aggressively long on vega can allow for profits even if the SPY moves against us. But our main goal is to reap profits by strong upward movements in the SPY. If you’re not confident of a strong upward movement but still suspect one, perhaps the next strategy is more up your alley.
#3 Expecting a Sudden Upward Movement… But Aren’t Quite Sure
So let’s say you want to bet in the more likely direction – upward – but still are worried that the SPY might crash. In this case, we can play a bull ratio spread, which allows us to open a position at a net credit but still be bullish on the SPY. If the SPY moves quickly upward, we profit; if the SPY moves downward (or doesn’t move at all), we get to keep the credit, therefore still profiting.
In this strategy, we mimic the ratio backspread strategy as above but ensure that we are playing with call options of the same expiration date. Bringing the long calls’ expiration date forward allows for a cheaper strategy and turns the initial cost into a gain. Consider the following play:
Here, we sell 1 December 230 call for every 3 December 240 calls we buy. This position is opened for a net credit of $40 to our account. But notice that the max profit is unlimited.
This is because the value of the 240 calls will increase in value more quickly than the one 230 call when the SPY moves upward. Once the SPY passes 240, we are essentially long 200 shares of the SPY. And this is all at no net cost to us.
#4 Sideways Movement around a Value
Now let’s say you expect the SPY to trend sideways. The beauty of options is that we can profit from this, while stock-only investors cannot. If you believe that the SPY is going nowhere for the next month, you can sell straddles.
In a short straddle, we sell put options and call options at the same strike price and expiration date. If we believe that the SPY will continue trading around 210 for the next month or so, we will sell SPY 210 calls and puts for July (it’s June now). Here’s the play:
A short straddle is simply taking the opposite side of a long straddle trade. The long straddle, by the way, is one of the worst options strategies in terms of statistical payoffs, implying that the short straddle is one of the best, statistically. The only concern here is the unlimited risk we take on.
But in the long-run, this strategy pays off. In this play, we collect theta income. Theta income is simply the time decay of the put and call options. The longer the SPY trades at or around $210, the more value these sold options lose.
We always want to buy back one of the options before option expiration to avoid being exercised on the options. Because the SPY is incredibly liquid, you can just set a market buy order for the ITM option on option expiration Friday. We will almost always be buying back the option for less than we paid for it, netting us two profits (the other is for the option that expired).
Conclusion
These four options strategies on the SPY should get you started in investing in the SPY via options the smart way. Instead of buying calls and puts, which are sold by market makers at inflated prices, we are always selling options as well. Thus, we also get to gain from the typical overpricing of SPY options.
Be like the market makers, not novice retail traders.
While using options trades like those above is a great way of booking short-term gains and boosting your investment income, they do not replace owning high-quality income stocks that you can buy and hold forever. In the market right now there are a limited amount of options for investors looking to earn a growing income stream from safe investments. And, with the Federal Reserve punishing savers like they are right now, buying a safe CD that pays good interest is no longer an option.
So, what are investors to do with their portfolio’s?
Disclosure: Tim Plaehn, income expert with Investors Alley, met with the CEO of one of America’s fastest growing specialty banks, and what he told me ...
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