You are one among millions of traders seeking constant income from investments in the financial world. The stock market is volatile and uncharted, and for most of them, it seems like a daunting challenge to venture into its complexities. Imagine if one could, however, get constant cash flow while limiting risk when the market fluctuates. The good news is there is a proven method—one that could help one achieve consistent income—and that is through options trading. Now, here is how to yield constant income in options.
Purchasing shares or mutual funds is but one means that can last a lifetime before returns are even visible. Should the market not behave as proscribed, reliance on stock appreciation as a means of producing monthly income is inefficient.
Options trading gives you the facility of effective cash generation by working on the price movements of stocks, indices, or ETFs like SPY—the S&P 500 ETF. It is versatile and powerful, where one can earn in the presence of a bullish, bearish, or even a neutral scenario of a market.
With options, traders can collect income with relative consistency through strategies such as the buy-write strategy—together without having to guess whether the stock market will sharply rise or fall.
Let’s dive into some details on how you can earn consistent income with options.
What is a Buy-Write Strategy?
Perhaps the most intuitive of all option income-generating strategies, known as the buy-write or covered call strategy, one generates an income stream by simply selling a call against a long stock or an ETF like SPY that mirrors the overall market. Here’s how to do it:
Step 1: You buy shares of a stock or an ETF like SPY that mirrors the overall market.
Step 2: You sell call options against those shares. In other words, you give another person the choice—but not the commitment—to buy your shares at a price agreed upon beforehand, on or before a specified date.
Step 3: You receive cash for selling those call options outright as a premium; that amount is yours to keep, free and clear.
The brilliance of this strategy is it captures option premium every month, irrespective of the direction the market takes. For instance, if SPY is trading at $450, and you sell a call option with a strike price of $460 for $2.22, you immediately bag $222 because each options contract covers 100 shares.
Why SPY Options Are Extremely Popular
This is a very attractive vehicle for the small account trader who wants some exposure to the overall market. SPY is a tracking ETF for the S&P 500 index and thereby represents more of a low-cost alternative in trading SPX—the options on the S&P 500 index. The options in SPY are priced at about 10% of the price of the options in SPX, thus making them much more accessible.
You can harness broad market moves through SPY without much capital commitment as compared to other instruments. You also have the luxury of a liquid asset, meaning it is easy to both enter and exit a position quickly, which is exactly what the buy-write strategy calls for.
How the Buy-Write Strategy Works: Practical Example
Now, let’s take a concrete example of this strategy so you can better understand how it works in real life.
Day One: The SPY is trading for $434.37. A buy-write investor buys 200 shares of SPY and writes two calls for a strike of $455 exercisable on October 20 for a premium of $222 per option. The total premium collected is $444.
Outcome #1 (Declines/Flat Market): If SPY ends up below the strike price—it closes at $421—then the call options expire worthless, and he sells both the shares and the $444 premium.
Outcome #2 (Market Runs Up to $455 or Just a Little Higher): If SPY runs up to $455 or just a little higher, the options are “called away,” that is, the shares sell for $455. The trader makes money from both the appreciation of the shares themselves—from $434 to $455—and the $444 premium.
In both situations, the trader makes money either through the premium alone or as a combination of premium and appreciation of the share price.
How to Use Continuous Income
Although the buy-write is pretty simple, here are a few things to consider so you can make the most of the profit:
- Strike Price: It’s best to use a strike price that is 1% above the current stock price. This leaves room for your stock to appreciate but lets you collect the premium.
- Timing Your Trades: Because options expire monthly (on the third Friday), you can line up a consistent strategy of selling calls and collecting income every month.
- Risk Management: Though the buy-write strategy is mostly low-risk, you need to keep track of your positions. For example, if the market collapses significantly, you may want to change your strategy so you do not lose money on the shares if they plummet.
Why the Buy-Write Strategy Grows on Any Market Condition
The buy-write strategy has so many advantages, but first and foremost, it’s so versatile. Here’s how it performs under different market conditions:
- Bullish Markets: When the market is rising, the buy-write strategy allows you to benefit from the appreciation of the underlying stock while the premiums collected from selling calls.
- Neutral Markets: Since the stock does not move much, it doesn’t budge in its price, yet one is still collecting premiums from calls sold.
- Bearish Markets: Even when the market declines, you still retain the premium collected by selling call warrants. So, even when the stock loses value, the premium collected would at least offset that lost value, and income becomes consistent.
Alternate Sources of Income: Dividends
The dividend is another form of income derived from holding any share, say SPY. SPY does not pay a large amount of dividends, but this means you also get another form of income with your buy-write strategy, making your cash flows smoother.
Conclusion
A significant ability, thereby allowing consistent income churning using options, especially through the buy-write strategy, has opened an avenue for traders on the way to creating monthly cash flow. Its flexibility and simplicity within a low-risk profile, of course, make it attractive, especially for the small accounts, for which this is a great tool for the masses of novice traders.
You develop an income-generating machine that will work independently, regardless of the type of market that exists: bullish, bearish, or anything in between. Be you a beginner or advanced trader, this strategy is one that will push your investment portfolio once you learn it. Now that you have been introduced to the buy-write strategy, learn some of the more advanced strategies you can add to your arsenal that will help effectively manage your financial future.