Three Rules for Profitable Options Trading
Earlier this week, I explained how to generate more than 18% in annual cash flow for readers of Income Millionaire by using a simple options strategy.
By writing a short put to buy the stock at a discount and then selling a covered call after we bought it, we earned nearly 6% in option premium in only seven months. Throw in a hefty dividend yield of 8.4%, and you have annualized cash flow in excess of 18%.
Today, I will show you how subscribers to my Systematic Wealth trading service profit from taking the other side of those options contracts.
Generally, it’s not a good idea to buy options. That’s because the vast majority of them expire with no value. However, that statistic is misleading because not all options are purchased with the aim of making a profit. A lot of them are used as insurance.
For example, a put contract gives you the right to sell your stock to someone else at a fixed price by a certain date. Since you own the stock, you would prefer that it continue to appreciate in value. But if it tanks, the put option acts as a safety net that limits your losses. Consequently, you would prefer that it expire worthless since that means your stock hasn’t taken a beating.
Conversely, some short sellers use call options for the same purpose. Since they make money when the price of a stock goes down, they limit their potential losses by purchasing the right to buy that stock from someone else at a fixed price by a certain date.
Therefore, you need to be careful about blindly accepting the truism that most options expire worthless as justification for not trading them.
For that reason, I employ a system for identifying stocks that have become either overbought or oversold. Then, I look for a corresponding put or call options that will jump in value when my analysis is proven correct.
Over the first six months of 2018, we closed six options trades that generated returns of 21.8%, 50.3%, 12.1%, 30.7%, 49.1%, and 203.4%. By the way, the average holding period of those six trades was less than nine days!
I know, it sounds “too good to be true.”
Admittedly, we have been on a good run so far this year. Not every trade will turn out to be a winner, and it looks like I’ll probably close my first options trade for a loss this week. But my other four open option positions are looking good, so by the time I close all of them out we should be solidly in the black for 2018.
It’s All in the Timing
As you might expect, the trick to successfully trading call and put options is in the timing. For that reason, I employ a three-pronged approach for identifying stocks on which to trade options:
1) They must score either very high or very low according to my IDEAL Stock Rating System, which is designed to determine the extent to which a stock is fundamentally mispriced compared to the overall market;
2) They must be trading at a short-term high or low price from a technical perspective, suggesting a reversion to the mean is imminent; and
3) There must be an upcoming “trigger event” that should cause the stock price to move strongly in the direction I am anticipating.
Let’s take a recently completed trade as an example.
On May 22, I issued an alert to open a put position in Autodesk (NSDQ: ADSK), based on my belief that the stock was overvalued and would drop after the company released its quarterly earnings later that week.
All the stars came into alignment that week. Autodesk’s IDEAL Score was zero, meaning it had become grossly overvalued and vulnerable to a pullback. It was trading well above its 50-day moving average near its upper Bollinger Band, suggesting a reversion to the mean was likely in the near term. And the quarterly results that week would include an accounting change that I believed would result in earnings coming in less than expected.
The day that alert was issued, ADSK traded above $139 before closing beneath $137. We bought a put option with a “strike price” of $137 that expired on June 1, just 10 days later. If ADSK rallied above $137, then my option would expire worthless.
Fortunately, my hunch proved correct. A few days later, Autodesk released quarterly results that disappointed the market and its share price quickly fell below $130. The put option that we bought on May 22 for $4.93 was sold seven days later for $7.35 — a gain of 49%!
If I had held onto that option for another day or two, my profit would have been even bigger since ADSK continued to drop before bottoming out on May 31, the day before this option expired. But I learned a long time ago that greed can ruin a good options trade, so I gladly took my quick gain and let the bottom feeders fight over the scraps.
Eager for even bigger gains? My colleague Jim Fink, chief investment strategist of Velocity Trader, makes this bold promise:
“If I don’t deliver 24 triple-digit winners in the next year…I’ll cut you a check for $1,950.”
Jim has already followed through with incredible results. And he’s about to release another special trade alert.
In it, he’ll share a way to multiply a single-digit stock movement into a triple-digit winner. But that’s just the beginning, because following his simple set of instructions each week could double your money up to 24 times or more over the next year. Click here to find out how.