Editor's note: Over the last month, a daily 2% move in stocks has become the norm. And that volatility has investors worried...
Today's weekend Masters Series essay originally appeared in our free Growth Stock Wire e-letter in February. In it, options expert Dr. David "Doc" Eifrig explains how to use the volatility to your advantage... and how to easily earn extra income in today's market...
How to Make Consistent Income in a Volatile Market
By Dr. David Eifrig, editor, Retirement Trader
It's one of the biggest mistakes that many novice option traders make.
They place a bet, cross their fingers, and wait until expiration to see how it turns out. But they never make adjustments.
There's a way to get a big advantage over that sort of "one-step" strategy.
You see, even though options expire on a set date, you can get out of a position at any time by buying back the options you sold.
Plus, option prices fluctuate constantly. That creates an opportunity for nimble option traders to earn extra profits or reduce risk throughout the entire life of the option.
Let me explain...
Today's volatile market is tricky for option traders. We need to get our timing right for any particular trade to be profitable. When markets fall just ahead of our option's expiration, it makes it more difficult to consistently book profits...
But we can still do it...
I'm referring to a strategy called a "roll."
A roll allows options traders to do two important things:
| • | We get to extend our timing window to make it more likely we'll end up profitable. |
| • | We get to collect even more option income. |
That's a good combination.
Now, let me walk you through an example of how we recently used this strategy in Retirement Trader...
On October 10, 2014, Retirement Trader subscribers sold puts on telecom monolith AT&T... specifically the January $34 puts for $1.25.
By opening this trade, we essentially said: "We don't think AT&T shares will be below $34 in January. But if they are, we'd love to buy them for $34." That's a good deal on the stock. We received $125 upfront for our promise to buy 100 shares of AT&T at $34.
In early January, AT&T was trading for around $33.50 a share. We made a good guess on the price, only off by $0.50, right? But it's even better than you might think. Even though shares were below our expected price, where we sold the put, it was still a profitable trade...
If the stock was still at that price when the option expired on January 16, we would have paid $34 per share and taken ownership of the shares.
At that point, we were still making a profit. We'd pay $34, but we already collected $1.25. So the shares really cost us $32.75. Since we could turn around and sell them in the market for $33.50, we'd make a profit of $0.75 per share.
That's not too bad. But what if AT&T shares dropped below $32.75 before our option expiration and we incurred a small loss? Or what if we didn't want to tap into our capital to pony up $3,400 for 100 shares? What if we preferred to keep earning income via put options with AT&T?
Instead of having an inflexible "one-step" strategy, we could keep our capital and earn even more income if we "rolled" the trade forward to another month.
So rather than wait until expiration to see if the price would rise or if we'd have to take assignment of shares, we closed our current option position and got rid of our obligation to buy shares. We did that by "buying to close" the transaction.
You see, as option sellers, we "sell to open" because we're opening a new position. When we close it, we have to buy back the option.
So on January 9, we bought back the AT&T put for $0.49. That's a good trade. We profited by $0.76 because we received $1.25 to sell the put.
But why stop there? We still like AT&T. AT&T is a quality stock at a cheap price. It's unlikely to decline much. And it's a stock we're willing to own.
So at the same time that we bought to close our January $34 put, we sold to open the AT&T March $34 puts for about $1.20. That means we collected a total of $1.96 per share (or $196 per contract) by sticking with AT&T – $0.76 profit on the first put, and $1.20 premium on the second.
This also means that AT&T prices can fall as low as $32.04 by March 20, and the trade will still be profitable. We may have to pay $34 per share, but $32.04 is our real cost ($34 minus $1.96).
As long as we still like AT&T shares, "rolling" the trade simply puts more money in our pockets.
Many people come to think of options trading as a situation where you make a decision, enter the trade, and wait until expiration to see what happens.
But the truth is, by keeping a close eye on your option trades, you can make adjustments and create easy ways to earn extra income or keep your trades safe. We call this "trading for income," a strategy to help you achieve a wealthy retirement.
Here's to our health, wealth, and a great retirement,
Dr. David Eifrig
Editor's note: Doc helps his Retirement Trader subscribers collect hundreds of dollars a month on the world's safest stocks. That's one of the reasons his win rate is more than 95% through almost five years of recommendations.
Right now, you can claim a 100% risk-free trial of Retirement Trader for the next six months. But if you're interested, don't delay... this special offer ends Tuesday, September 8. Click here for the details.