What is most interesting about financial markets is that fact that with just a few hundred dollars, anyone can open an online brokerage account and give their shot at making money in the markets.
Very few industries provide such a small barrier to entry with such small capital requirements.
Many people see the lure in day trading. They see videos on Youtube of traders making thousands of dollars in just a few minutes. You can definitely make a living on a few thousand bucks a day!
Hell, sign me up for that too!
Selling option premium is a type of investment strategy very few are familiar about. Throughout the rest of this article, we will speak about what selling options premium is and discuss if selling options for a living is legitimate or not.
Selling Option Premium
Readers of this blog should already be familiar with what options are but if you don’t, here we go.
Stocks have over the counter derivatives known as options. These options represent 100 shares of stock. They can be bought or sold.
Most people in financial market circles only really speak about purchasing options. Here the buyer of the option pays a debit to the seller.
Obviously on the other side of the transaction is the seller. The debit paid to the seller by the buyer is the credit that the seller will receive. For out of the money options (puts where the stock price is above the strike price and calls where the stock price is below the strike price), this credit received by the seller is known as premium. No matter what, the seller receives that premium and the amount is deposited into their account when the transaction occurs. Selling options and receiving a credit to do so is known as selling options premium.
Why Don’t More People Talk about Selling Options Premium
When we sell option premium, our maximum profit is set to a fixed number. If we were to sell a call for $1.00 (we collect $100 in this scenario), that is the absolute most we can make on the trade. Wall Street tells us to let our winners ride and we cannot do this when our upside is limited. This is the main reason why nobody talks about selling options premium; it does not go with the Wall Street motto of cut your losses and let your winners ride.
On top of this, selling uncovered naked calls can come with unlimited risk. While this is true, shorting stock can come with unlimited risk while at the same time, buying a $100 stock does not come with unlimited risk but buying 100 shares of that stock does come with a $10,000 risk.
Selling Option Premium…Theta
When we sell option premium, we create positive theta decay.
If there is a value left in the option that we sold, we will have positive theta decay. That theta number is equivalent to what the market believe’s will be taken out of the value of the option every day (including weekends). Another way to look at this is theta is the amount of money we expect to make every day by selling options premium and creating positive theta decay.
Selling Options For a Living
Now to the fun stuff. Recall when we sell and options, we get a credit for doing so. That credit (cash) is deposited into our brokerage account upon transaction. This is known as selling option premium. The premium that is collected has something called theta, which is the value that will be removed from the price of the option we sold each day.
Now, if we want to talk about selling options for a living, we just need to break it down into a very simple equation.
Let’s say we would like to make $50,000 next year and decide we would like to do so by selling option premium. How much theta decay would we need to create each day for that to happen? Simple.
365 days in the year. Our goal is 50k.
$50,000 (how much we want to make) / 365 (day in the year) = 137
We would have to collect 137 a day in positive theta decay. While it is not the easiest thing in the world to create 137 a day in positive theta decay, the formula for how much we have to create is. Selling the at the money $2340 $SPX call expiring the third Friday in March will give us 38 a day in positive theta decay. Selling four of those gets us to our goal.
Think 50k is too high? What about 10k?
$10,000 (how much we want to make) / 365 (day in the year) = 27
Selling 5-6 at the money $SPY $233 puts expiring the third Friday in March gets us there too.
Any way you twist it, it is possible to hit all of your finance goals in the market by selling options for a living. Break it down, it’s not overly complicated folks.