Options ladder. What ladder?

Options ladderA few years ago when banks paid 3, 4, 5 or even more per cent interest on deposits such as CDs (Certificate of Deposit) or some savings accounts people were creating ladders. It was a quite popular method of creating an income stream.

If you had a substantial amount of money, you could spread them among long term CDs and then lived off of it. For example, if you had 100,000 dollars available, you would split them into 5 smaller amounts of $20,000 each and bought one 5 year CD the first year. The next year you would purchase the next 5 year CD and so on. After 5 years you would have your ladder constructed. The sixth year your very first CD would have matured. You could take your principal and reinvested it into the next 5 year CD. You kept the interest and spent it for living. Of course you would have needed a lot more than 100k, but you get the idea. Many people have used this strategy during their retirement.

If you are somewhat advanced in finances, you know what the ladder strategy is and how to construct it. If not, read the article How To Create A Laddered CD Portfolio for more information.

Years of dreaming

Image courtesy of David Castillo Dominici / FreeDigitalPhotos.net
Dreaming boy

It was a strategy I always admired. As a kid I wanted to have a stream of income. I wanted my money working for me and bring me more money. But I didn’t want to invest my allowances and then wait 20 years to enjoy the results of my investments. I wanted to enjoy my investment now! Every month I wanted at least few pennies available in my pocket and spend them whenever I wanted and for whatever reason and yet knowing that the next month I would have another payday of a few pennies available to spend them. It was a great feeling. I didn’t have to ask my parents for more money. They were flowing into my little savings account themselves.

Jesse Livermore, a great investor of the 20th century always said that if you make a profit, withdraw 50% of it and spend it anyway you want. Enjoy the result of your successful business.

I liked that idea a lot. I do not do it yet since I reinvest all my proceedings, but I really look forward the day, when I start withdrawing 50% or more of my proceedings and spend them the way I want.

A little banker growing

I was a special kid in case of finances. As soon as I started receiving allowances I was saving it all. I kept a record book of all my money. I always recorded when and from whom I got the cash, be it my mother or grandparents. I was 10 years old.

A little league workforce

As soon as I could work part time, which was when I turned 16 (and since we lived in a small town I could actually start earlier as the employer pretended I was older), I started working for the postal service during the summer break. Every payday I went to the nearby bank branch and deposited my money to my very first savings account.

I counted every penny I received as an interest and I was watching my little account growing. It was at the times, when saving money in these products such as savings accounts, CDs, or money market accounts made sence. At today’s low interest environment investors have very little opportunities.

Joining the dividend growth club

And that’s why I decided to go for and love dividend investing. The dividend investing strategy accomplishes exactly my childhood dream of everlasting and growing income. The dividend investing fascinated me for this exact reason of passive income. But in my early years I didn’t understand dividends. When I was depositing my hard earned cash to my savings account bearing 10% interest, I considered 3% dividend a losers (suckers) game.

I completely missed the power of dividend growth and compounding. But I learned.

A birth of a ladder

The other day I was reviewing my tracking system and stumbled upon my calendar. Recently, I opened a new trade and I sold a put contract against Taser International and received a nice premium.

This trade made me thinking about my options trading. I was staring at this calendar at the same time:

When thinking about my other recent trade of put selling against Safeway comparing it to TASR trade and comparing it with my decision selling puts every month reaping only 30 – 40 dollars because I didn’t want to wait 5 or 6 months for expiration I got an idea.

Can you see the pattern here? It suddenly struck me. Why I have a few trades expiring at the same time while I can spread them across the whole year and create a ladder?

I liked the idea and decided to try it. I will be now selling my puts so I will have at least one put contract expiring each month. This strategy would also allow me taking a long term expiration and thus bringing in a lot larger premium than just 30 to 40 dollars per contract. Now it can be $100 – $300 premiums. The risk will be the same or maybe smaller since the stock will have more time to act and I also will have more time to react and it will be a nice game for me.

It will keep me busy :)

What is your opinion?

What do you think? Will the options ladder be a good and working strategy? Would you apply it yourself?
 
 





6 responses to “Options ladder. What ladder?”

  1. […] @ Investing into Stocks – Hello Suckers! writes Options ladder. What ladder? – My plan on creating a ladder of options and have at least one option expiring each month to […]

  2. CI says:

    Hi Martin!

    Two thoughts running through my head:

    #1 if I could earn 10% interest in a FDIC insured bank account, I’d take it over dividend growth stocks! Unfortunately 10% interest probably wouldn’t last very long, but I would likely lock in at that rate with bonds.

    #2 Having all those options expiring at the same time could be stressful! Chances are you won’t lose much sleep if they are spaced out. Being able to sleep well is important.

    • Martin says:

      CI,

      you are right, if I had 10% savings account I would do the same, but unfortunately it’s no longer available worldwide. And if it is, it probably be a scam. But in 80s and early 90s it wasn’t anything impossible.

      I haven’t seen it stressful so far having three or four options expiring at the same time, maybe b/c I was lucky enough so far. I only had one option where I had to sit behind the screen with a thumb on a buy back button monitoring the price action bouncing and trembling around the strike price. But I bet if I will be able to spread it throughout the whole year it would make things easier on me, definitely.

      Thanks for stopping by.

  3. Bret says:

    It works, but it also creates a huge risk. If the company suddenly drops out of the sky, you have to buy a lot of shares. If you spread it across multiple companies, you will have more safety, but then you still have the risk of a full-on market crash/swoon. I’ve lived though doing exactly that – it wasn’t fun.

    Like anything, there is no free lunch, the more you put to work, the greater your risk, and really – the larger your cash account should be.

    Perhaps my method is conservative, but I like to imagine the cash minus the option premium is already spent until I either buy back the option, or it expires. Alternately, I can buy a put for something of a lower strike, and then my risk (cash allocated) reduces.

    Some examples. XYZ put sold at 20 (say it was 1.00 made). This means I need to allocate (mentally) $1900 in my account and not spend it. It’s hard to have the patience.

    Worse yet, you probably don’t want to be allocating 100% of your cash in this rising market, so save whatever portion – either inside or outside of your trading account, so you can put it to work later when prices go on sale.

    Anyway, regarding buying a put, you might later buy a put at say $15. This turns it into a spread in options lingo, but it means if the price suddenly drops, your spread limited your losses – assuming the $15 cost you 0.5, then your max loss is 20-15+1-0.5 =$450. Even better, you can sell your very profitable put, or just close the (now limited) loss of the two contracts.

    It may seem a bit crazy to spend some of your hard earned cash on someone else’s put, but it frees up your cash. If your options trading fees are small enough, things like puts going for 0.05 to 0.20 puts can put real limits on the maximum loss, and thus you can allocate your cash to more trades, all the while knowing you have some protection on them should things go wrong.

    • Martin says:

      Bret, I totally understand that and yes I will only have one company per trade in the ladder. I will not be creating the ladder out of the same company for that exact risk you are speaking of. Also I will be creating it out of companies I am OK to buy at the strike price and not other companies, so if it happens and the stock falls and I get assigned I will not be suffering a heart attack. This was my biggest issue in the past that I was selling against companies I didn’t want and later I suffered a lot of stress. Now I am selling against companies I want to own anyway and against companies where a sudden drop is unlikely (although everything can happen). If you take a look at my calendar I already own a few puts and calls, but all of them with the same expiration, now I want to spread it a bit over time and get to the point that instead of selling next month option I will be selling 6 months option and the next month option when expired I will be selling a new with 6 month expiration and move forward.

      I have cash reserves out of the account and trade options on margin so if I get called I can quickly move cash to my account, or if I want to postpone the assignment I can roll or leg into a spread. It depends on situation although a spread not always protects you against an early assignment anyway.

      As far as rising market, it is a concern which makes me play it carefully and it also means that I will not trade only puts, but calls as well.
      Thanks for stopping by and contributing.

  4. Great post, Martin.

    I’ve been thinking about something similar over the last few weeks. Currently I am only writing options (only writing covered calls for now) that expire in one month and have been contemplating of building a ladder of sort, of expiring options.

    I need to come up with a strategy of how to ladder them – 2, 3, 4 months away etc.

    • Martin says:

      I think it will work. The best benefit I can see is that with a ladder you will be able to take longer expiration times for your calls rather than only a month and thus collecting larger premiums. For example I will have three options (one Safeway and two GLW) expiring in November. Instead of selling monthly I will sell one for December, next for January and the third for April since I already have options for February and March. And as the December option expires I will seek for selling next one in May, then January will be sold for Jun, etc. Should work.
      Thanks for stopping by.

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