One of the things that naturally attracts traders to the options market is the leveraged nature of options contracts – the idea that you can get more “bang for your buck” by trading options that you would get by trading the stock itself. That is technically true, but in my experience it is also a mixed bag, simply because any momentum or swing-based, directional trading system is always wrong more often than it is right. My own trades along these lines have taught me that I can expect to have just about a 25% success rates when my focus is directional in nature. 

It’s definitely possible to make money with directional options trades, and when you do hit a winner, it’s usually a big one. You may very well be able to double the money you put into a trade in just a few days if you can time it right – and that can happen in options with just a few dollars of relative movement from the underlying stock. Sounds great – until you also consider the reality that leverage cuts both ways. If you aren’t right about the stock’s direction, that option’s leveraged nature, along with limited time value can quickly work against you and erode the value of the contract right in front of your eyes. Now add to your calculation the chances that you are going to be wrong 70% to 75% of the time. This reality, and the difficulty it imposes on profitable trading over time, is the primary reason that years ago I shifted my focus away from strictly directional options trading and began to focus more on income generation by selling options premiums.

The part where people tend to get a little confused comes when they find out not only that all of the upside in the put selling, income-driven trades I place with the Rebel Income system is in the premium I get when I place the trade, but also that my objective is to average a total yield of about 1.5% per month. Why settle for so little, when I can do so much better with those big-bang, double-your-money directional trades?

My first answer always goes back to probabilities. Yes, I can double my money from time to time with a good long call or long put trade. But if my chances of being right about the direction a stock is going to go when I place those trades is only about 1 out of every four trades, then the chances I’ll double my money in any one of those winners is probably only about 50% at best. When I lose, I usually lose about 30-50% of the capital I put into the trade, which makes the long-term success of that system even more difficult. It’s one of the biggest reasons I’ve seen so many people start trading options with great excitement, but eventually get discouraged and call it quits.

The chances of success with put selling, on the other hand, as I use it in Rebel Income is much, much higher. You can see the results for yourself in my Trading Log, which spans almost six years of trading activity. My success rate in these trades – meaning that the position was ultimately closed, sooner or later, with a net gain – is more than 97%. Taking a 97% win rate versus a 70% to 75% losing rate seems like a no-brainer in my book – and if that means “settling” for a 1.5% return rate per month, then you can go ahead and count me in. I won’t beat the S&P 500 in years like 2019, but that really isn’t what I’m trying to do. I’m just trying to generate useful income on a consistent, steady basis to provide a measured, high-probability path to long-term success. I think it works no matter whether your objective is to use the income, or to build long-term wealth over time. Think about it: if you can generate 1.5% return per month, month after month, you’re bringing in about 18% in annualized returns per year. Now repeat that process year after year, and you have a terrific recipe for long-term success.

Another element I get asked about why I tend to use short expirations when I sell options. I’ve talked to a lot of income traders over the years, and seen many of them sell options out for as long as a year because they bought into the logic they’d get a fatter immediate payoff by selling more time by only making a few trades per year. I’ll admit that I get a little frustrated by this mindset; I liken it to “tripping over dollars to pick up pennies.”

The truth is that even though selling shorter periods of time give you smaller immediate premiums, the cumulative effect of those smaller, more frequent payments give you significantly bigger returns in the long run. Here’s a simplified example of what I mean:

I used a small trading account balance for purposes of simplicity; but you can certainly see the big difference making more trades over smaller periods of time produces. One of the criticisms I used to see – until last year, anyway – was that you would incur more commissions by trading more frequently. With the majority of online, discount brokerages now operating with either no-commission trades, or options trades with commissions of less than $1 per trade, it no longer really matters. It really just provides that much more ammo on my side that you should be working with shorter, not longer time expirations with your income trades. If you’ve been following my trades for a while, you know that the numbers I’m showing here are VERY reasonable and possible, because we’ve seen a lot of stocks in that time provide exactly these kinds of opportunities.

The other reason for using shorter expirations goes back to probabilities, and it is tied very closely with time decay. Remember that when you buy options, time is working against you; every single day, some of the time value of the contract erodes, and if the stock doesn’t move the way you need, you will also lose equity value. It’s a double whammy that accelerates losses and makes the low probability of success that much harder to overcome. On the other hand, selling options puts time on your side, which means that you actually want that time decay to occur. If the stock is above the strike price you sold (I always sell out of the money for this reason), there is no equity value in the contract, which means that it is almost all tied to the time in the trade. If you follow the logic that in the long term, stocks tend to go up more than they go down, then it follows that in the short-term, prices will remain more volatile. That assumed volatility (called implied volatility for options Greeks measurements) is part of what makes the premiums for short-term options attractive for the seller. It also follows that selling shorter periods of time increases the chances that the stock won’t finish below the strike price I sold, which then opens up the opportunity to repeat the process again the next week, which activates the compounding effect the table above illustrates.

Rolling Your Trades

Another part of trade frequency that I know a lot of income traders like to use, and that I like to include in our weekly webinar discussions, is to roll an income trade prior to expiration rather than waiting for the expiration to happen. If you’re doing this with a put sale, and the stock is sitting above the strike price you sold relatively close to, but before expiration, you can usually buy the same strike price back from the market to close the position. That eliminates your potential obligation in the trade, frees up the margin or cash you were required to hold in reserve to secure the put sale, and allows you to place even more trades than my more conservative method applies. Again, in this case, greater trade frequency can translate to an even more elevated compounding effect, which can work even more in your favor.

Another question about rolling your income trades prior to expiration is how to handle situations where the stock has dropped below the strike price of the put you sold prior to expiration. In this case, you could be assigned shares of the stock at any point up to the expiration date (assuming you’re working with American-style options, which is almost always the case for the trades I highlight). I don’t avoid these situations, because I tacitly accept this as a potential outcome for every put sale trade I place; for me, the put option’s strike price represents what I think is a good value price for the stock, so in this respect I use put selling as a gateway to stock ownership. That means I’m willing to ride through troughs – including sometimes very long-term ones – that result from stocks that stay well below my assignment for an extended period of time.

If the stock drives below the strike price you’ve sold, and unlike me, you don’t want to accept the assignment, buying the contract back prior to expiration still removes the obligation. The difference now is that you will have to pay more to buy it back than you brought in when you sold the put, so this position would result in a net loss; but compared to the situations I tacitly and purposely accept from my use of assignments, your loss will be smaller. Since the majority of your cash or margin capital reserve is not freed up (less the amount lost), you can decide whether to roll to a different expiration on the same stock, perhaps at a lower strike price, or whether to move on to something else. The advantage you get, along with improved flexibility, is the opportunity closing the position quickly gives you to limit the loss you incurred to a much shorter period of time. Generally speaking, that loss should be easier to make up than some of the cases I choose to deal with by waiting for sometimes a year or more for a stock I’ve been assigned to come back to the strike price I was assigned at.

If you are a new subscriber, please take some time to review the videos in the Getting Started area of the website. These will give you a pretty comprehensive view of the value-oriented approach I use to generate income with put selling and covered calls. You will also find it useful to read my Frequently Asked Questions article. Also feel free to review my previous posts as you’ll find additional answers to many of the questions you may have.