Three years ago I started trading options. I started with covered calls first, later moved to selling naked puts. Was I successful? Yes and no.
I made money and I lost money. My trading was like a roller coaster.
Euphoria was replaced with deep disappointment and anger when I doubled my account in one season and lost it all in the next one.
I was looking for a strategy which would work and make money consistently. Even naked puts which I thought would be an easy trading couldn’t do it. And I was running out of money to trade naked puts.
So I turned to spreads.
I made money and I lost money. And my strategy still didn’t work. I started trading SPX options. I made a lot of money. And I lost it again. All my trades provided with good excitement but they all were dangerous and risky. Every expiration I felt a stomachache worrying where the market ends.
I knew what I wanted to trade, but still didn’t know how. It seems like this is something every beginning trader is going through.
After desperately searching for the new way of trading I decided to adjust my strategy to make it safer, increase my probability of success and make money consistently without stomachaches.
Here is how I will be trading options.
I trade options spreads against SPX
I decided to trade options spreads against SPX only. No stocks. I want to focus on the market, be in sync with it and not get distracted by stocks, announcements, earnings, or any other aspects which move the stock price and create distraction.
For that I will only trade bull put spreads, bear call spreads and Iron Condors against SPX. If needed, I may adopt other options structures as a way to save a trade, for example converting a spread into a butterfly, etc.
I trade SPX options spreads with 45 days to expiration (DTE)
Before I traded 4 days DTE spreads. I opened a trade on Tuesday which was supposed to expire the same week on Friday. With the market volatility as seen throughout 2015 many of my trades got wiped out. The probability of success was very low.
By trading 45 DTE spreads I could widen my strikes and increase my probability of success beyond my imagination.
I trade 45 DTE SPX options spreads in a ladder to simulate weekly trading
I loved trading weekly options, but they were risky and unpredictable. I was thinking how to trade 45 days options weekly. I decided to create a structure I call a ladder. A period of 45 days represents seven weeks.
To start a ladder I sold one trade per week. After seven weeks I achieved opening a new trade on Tuesday and have expiration that same week on Friday. Exactly the same as when I traded my 4 DTE options. The only difference now is that on the seventh week, I open a seventh trade but my first trade is the one which expires. In eight week I open a trade #8 and my trade #2 expires and so forth.
The first 45 day cycle when I started a ladder I had to wait 6 weeks to achieve weekly expiration.
Same illusion of weekly trading, but a lot higher probability.
I use standard deviation channel and linear regression channel to set up a trade
In my Think Or Swim (TOS) program I use 9 months SPX chart with two studies – a standard deviation channel and 50 day linear regression channel. They are set up to represent 1st standard deviation and 2nd standard deviation.
When placing my call spreads I want the short strike to be as close to the 2nd standard deviation as possible or above it. But when opening that spread I want to collect min 30 dollars premium.
When opening my put spreads I use delta 8 – 10 for my short strike to open the spreads.
This increased my probability of success to 92%
I trade SPX options spreads with 40 dollar wide strikes
I started opening new spreads with five dollar wide spreads. But my goal is to reach a 40 dollar wide spread before I start adding more contracts. I believe, wider spread is better than narrower.
Why is wider spread better?
First of all, it is safer and you actually risk less money if the trade goes against you. You receive more credit per contract and commissions are same as if you traded a narrow spread.
For example, if you open a five dollar spread, you receive 30 dollars premium and pay approx. $11 in commissions (depends on which broker you trade with). With a 15 dollar spread you get 80 dollars premium and also pay approx. $11 in commissions.
To get 80 dollars premium, you would have to open at least 3 contracts (assuming each can bring 30 dollars only) and with that, you will pay around 20 dollars in commissions.
The chance that the price of SPX slices thru both strikes is lesser with wider spread, so potential loss is smaller compared to a full loss of more contracts of a narrow spread. And here is the safety of the trade. If for example you trade a 2035/2040 put spread and 2000/2040 put spread, it is very likely for SPX to drop below 2035. And if that happens, this trade is in full loss, while the second trade is still only slightly in relatively good shape as you are losing only a small portion of the entire risk.
For this reason I will be widening my spreads as time goes on.
I open SPX options spreads on Tuesdays
I do not open trades on Mondays and Fridays. I have seen experienced traders avoiding these days. I do not know the details why, but I adopted that policy. John Carter for example doesn’t open trades on Fridays (maybe because they are expiration days). Other traders and schools do not open trades on Mondays. So do I.
However, as my account grows I plan on opening trades not only on Tuesdays, but Wednesdays and Thursdays too.
Defending my trades
This is the hard part. I didn’t like defending trades. If I had to defend trades or close them, it was always for a loss and I hate taking a loss. All my search for a strategy was to find one where I do not have to defend a trade.
Although, I believe I have a strategy where I do not have to defend a trade, if it however happens and a trade goes against me I need to have a plan what to do.
I will not roll the trades as I did before. If any of the spread gets touched, I will either open an opposite spread or in case I already have a Condor I will move the untouched spread down and create an Iron Clad trade. Then I let the entire trade expire as is. There will be a loss, but smaller than if I did nothing or rolled trades away in time.
Once I will have more contracts opened I will attempt reducing risk by closing half of the spread when the spread gets touched. But I will only do this 7 days to expiration. If there is more days left, I will do nothing as it is very unlikely for the market to drop so deep (or raise so high) without recovery or correction.
Follow my trades with my free newsletter
I will be publishing the trades in my free newsletter showing each trade as I will be putting it on in my trading platform. So you can watch, follow, or even trade those trades with me.
You will be able to see the open trades and number of contracts in “My Trades & Income” tab on my blog. I will also post these trades in “Calendar” where you will be able to check expiration of each trade and the entire process of creating and managing the options ladder.
Trading options vs dividend investing
Dividend investing is a great strategy, but now I look at it slightly differently. I no longer consider the dividend growth strategy my main investing or trading goal. I however look at it as my wealth preservation.
I have seen some traders investing their proceeds to other instruments or investments. Some invest the proceeds to gold or silver, some buy land, others real estate. I want to do the same. Or similar to be exact. I want to be buying dividend stocks.
I understand that at some point in my life I will no longer be able to actively trade options. Dividend stocks will be here to subsidize trading. My options trading is here to create an income now. Not 20 years from now. Now I want to trade, grow my account and enjoy income from trading. Once I will not be able to trade (maybe 20 or 25 years from now), I will have my dividend stocks to take over.
For this purpose I will trade this option strategy in my taxable TD account and in my ROTH IRA account.
To grow my accounts and enjoy my income I have the following distribution rules.
In my TD account:
For every $1,000 monthly income I withdraw $200 for my own use and spending (paying bills, debt, vacation, but also buying dividend stocks, or saving to my ROTH IRA account). After I reach $10,000 monthly income, I will take out 50% for my own use. The rest will be left for taxes and account growth.
In my ROTH IRA:
After I reach $2,000 monthly income I invest 50% of that income into dividend growth stocks. The rest will be used to grow my options trading portion of the account.
In my ROTH IRA account once my options trading generates $2,000 or more per month I will invest 50% into dividend growth stocks. This means I will invest $1,000 or more monthly into dividend growth stocks.
To choose a stock I want to invest in I created a screener which selects the most undervalued stocks for me. All I have to do is to look at the stock’s rank and invest in it. I publish the results of the screener below. The lowest the rank the more the stock is undervalued.
If any of the stock changes from “Buy” into “Avoid” or increase the rank I stop investing into such stock but I keep it in the portfolio. I only sell if it stops paying dividends.
In my TD account I do not invest into stocks and I sold all positions when adopting this strategy. My TD account is now only for options trading.
I wish you good luck and a lot of money :)