How I Trade Options: Selling Vertical Put Spreads with Small Amounts of Capital

How I Trade Options: Selling Vertical Put Spreads with Small Amounts of Capital

How I Trade Options

My favorite options trade is selling the vertical put spread. I use the Tastyworks brokerage because the fees are low and the platform gives me a visual guide that is not available anywhere else in the world.

By using small amounts of capital, I can place a low risk trade, collect premium, and close the trade with a profit in a week or two. This type of trade is not time consuming, which is important for traders like me who also have a full time day job.

What is a put?

A put is an option that gives the purchaser the right but not the obligation to sell 100 shares of a specific underlying stock for a specified price at a certain time. When you buy a put you are expecting the stock price to drop.  When you sell a put, you are expecting the stock price to either stay the same, or go up.

http://www.countdowntosailing.com/wp-content/uploads/2018/05/Put-Option-Transaction-Diagram.png

Vertical Put Spreads

The definition of a vertical put spread according to the Options Index Council:

“A bull put spread involves being short a put option and long another put option with the same expiration but with a lower strike. The short put generates income, whereas the long put’s main purpose is to offset assignment risk and protect the investor in case of a sharp move downward. Because of the relationship between the two strike prices, the investor will always receive a premium (credit) when initiating this position.

This strategy entails precisely limited risk and reward potential. The most this spread can earn is the net premium received at the outset, which is likeliest if the stock price stays steady or rises.” https://www.optionseducation.org/strategies_advanced_concepts/strategies/bull_put_spread.html

 

How I Pick Equity Stocks & ETFs to Trade

There are a handful of stocks that I follow daily, and have done so for months or years. These stocks I’m inherently familiar with their normal behavior, trading channels, and resistance/support levels.

I don’t spend a lot of time reading charts – I don’t really need to for these stocks, as I’ve developed an intuitive feel for how they move. I look for opportunities to sell premium.

The stocks/indexes I currently follow are: $AMD, $VALE, $MU, $SPY, $GE, $TSLA, $SPX, $IWM, $FB, and a few more.  Here is a snapshot of my “Sail Away” stock list from my tastyworks account that I created a few years back, and update regularly.

Tastyworks Sail Away Stocks

Tastyworks Sail Away Watch List

I keep the list short because I don’t have time for more. I work a full time salaried job and have a baby at home (in addition to being 7 months pregnant!).

My Method of Selling Vertical Put Spreads

I prefer to sell my put spreads on down days. Tastytrade refers to this as “selling into strength”. This way I can take advantage of a price movement that’s already down, which often comes with added volatility, which increases the premium I receive on the trade.

I look for trades that net me around $50 – $75 for a 1-lot. This could be anywhere from $1.50 – $3.00 strike wide.

For example, on 5/7/2018, I sold the $14 strike and bought the $11 strike of $VALE for $58. That means I collect $58 up front. I will wait to close the position until I can buy it back for around $25, netting me $33 in profit less trade fees. I sold the Jun 15th expiration, which was 39 days away when I sold it. The Theta on this trade is .50. This means if the stock price doesn’t move at all, I should collect around 50 cents per day until it expires.

This may not seem like much premium, but the capital requirement for this trade is only $242. If I successfully close the trade at $25, netting $33 less $1.40 in trade fees, I make 13% profit on my capital.

My return rate may not sound sexy to you, but think about the time frame. If the trade is opened and closed in 2 weeks, that’s an annualized return of 338% (13% / 2 weeks * 52 weeks).

UPDATE:

The $VALE trade ended nicely.  I bought it back on May 11th for $28, for a profit 12% in 4 days on a capital outlay of $242.  Annualized, that’s a return of 1,095%.  Of course, not all trades can be sold this quickly, and not all go in your favor right from the start.  But if you keep your trades small, you can minimize the risk of losing a big chunk of change at once, and increase your chances of winning.

Here are screenshots of the closing trade:

Tastyworks $VALE Closing Trade Screen

Tastyworks $VALE Closing Trade Screen

Tastyworks $VALE Closing Trade Confirmation Screen

Tastyworks $VALE Closing Trade Confirmation Screen

Here are some rules I follow:

I never wait for a position expire.

I always try to close it out around 45% to 70% profit.

I target the 30 to 45 day range for expiration when I place the trade.

If a position is at a loss with two weeks until expiration, I roll the trade to a later expiration to give it time to become a winner.  Rolls can be done consecutively, as needed.

Super Conservative Trades

On big down days on the market, I like to sell a far out of the money put spread on $SPY. These will net me a meager 10% return on my capital. But they are so far out of the money that the probability of profit is around 85% to 90%, so the odds of winning are huge. Those are the kind of odds that you can count on to make you money long term.

It’s a really boring and safe way to trade, but a solid method.

I did not learn how to trade options over night. It took a lot of watching tastytrade, learning the tastyworks platform, and making a lot of stupid, risky trades before I learned to play it safe. Now that we have goals on when to buy our boat and quit corporate life, I’m more focused than ever on making safe trades.

Options trading resources I use:

Tastyworks brokerage – I couldn’t trade options without their visual platform.

Tastytrade – everything I learned about trading options I learned from them – for free (along with my own personal experience).

I recommend opening an account and placing trades while you learn.  Losing a bit of money up front is expected – but you can’t really understand how option pricing moves over time without having a bit of skin in the game.  I’m not a fan of paper trading.  I don’t think it has the same teaching effect as real trading.  Open a small account, make some small, basic trades following Tastytrade, and learn how to manage your risk.

Please comment below or ask questions about trading!

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