Generate Steady, More Reliable Income with Option Premium Ladders
Staggering expirations is a cornerstone you need to Build a Consistently Productive Account
If you were to get me on the phone to ask questions about a managed option selling portfolio, one of the first things I would ask you is this: “What are your reasons for wanting to invest in such an account?”
If you are like most investors, you will answer something to the effect of “to make money,” “to grow my capital” or “to generate income.”
All worthy objectives.
What you may not mention is how you want to obtain these goals. If you are like most, your unspoken part of the answer is “I want to make money with the least risk, least stress, least drawdowns and most consistency that it can be done.”
But you won’t say that. Because we all know that any investment, including selling options, involves risk. And to acknowledge fear is often against the “comes with the territory” bravado common to alternative investors.
“I want to make money with the least risk, least stress, least drawdowns and most consistency that it can be done.”
You won’t have to say it to me, however. I will say it for you because I am the biggest coward in the world when it comes to putting client equity at risk. I hate risk, I hate stress, I absolutely hate drawdowns and am constantly looking to improve consistency. Fortunately, selling options has built in consistency that can already give you a big percentage of winners for every loser. What can likely make your option writing portfolio a more prized allocation however, can be a smooth equity curve.
Investing for Return, Not Excitement
Generating a great return can be tremendously gratifying. However, if you are like me, it may not be worth the trouble if you have to ride a roller coaster to get there. You’re investing for return, not excitement. Double digit returns may be what you are after, but getting there in a nice, smooth reliable trend upwards would be desirable to wild monthly swings, dips and recoveries.
Riding a Roller Coaster may be a fun time with your kids. But it’s likely not the experience you are seeking with your Option Selling Portfolio.
To that end, one key element I have found to incorporate into our strategy is not only diversifying the markets in which portfolios sell options, but by diversifying expiration months. We have termed this strategy staggering options. If you are selling options on your own, you can use this strategy in your own portfolio to increase your consistency.
Staggering short options is a popular strategy with both income and total return investors. You may hear some comparing this strategy to building a bond or CD “ladder”, in which you have paper maturing in every month of the year. The strategies may be similar, although your option premium ladder will carry more risk with the potential for higher returns. This approach is featured in The Complete Guide to Option Selling new 2014 edition now available at www.OptionSellers.com/Book. It is an important part of structuring your portfolio and can play a big role in the consistent performance of your portfolio.
Staggering or “layering” your options is a concept of selling groups of options with different expiration months with the objective of having a certain amount of options expiring every month.
For instance, an investor wanting to stagger his portfolio make take the following approach:
Option Premium Ladder using Staggering
Month 1 – Sell options 90 days out
Month 2 – Sell options 90 days out
Month 3 – Sell options 90 days out
The objective of this approach is to set the portfolio up so that you have options “scheduled” to expire in every month of the year – thus providing a steady stream of income or rate of return. By the end of the first 90 days, your first set of options will be expiring. As these expire, you continue to roll them into another set of options 90 days out and continue this cycle throughout the year. Of course, you could do this at 120 day intervals or 150 day intervals as well. However, by incorporating this ladder building approach, you should have at least some options expiring nearly every month.
Staggering your options throughout different calendar months can provide a more consistent equity curve as well as help reduce risk.
You can employ this strategy using options in the same market along with options in different markets. As most commodities options do not have options available in every month, a mix and match approach often works best. For instance, you could sell crude oil options the first month, coffee options the second month, soybean options the third month. If the same supply/demand fundamentals continue, you could repeat the cycle at the beginning of the fourth month.
Advantages of Building Your Premium Ladder
Positioning in this way offers you two major advantages:
- As already mentioned, it can provide a more consistent stream of income (or posted returns) with options expiring every month
- It can be an effective tool in helping to manage your risk. As options approach expiration, their ability to cause you losses becomes diminished. By staggering your options, your risk is effectively spread around between low risk and higher risk options. The highest risk options tend to be the newest options that you’ve just sold – the ones with the most time. As time goes on, the risk diminishes- especially if they remain deep out of the money.
If you plan to use option selling as a core portfolio strategy and not just an occasional way to generate excess income, building a premium ladder is a key method of building smoothness and consistency into your overall approach.
Investor Discovery Pack & Starter Guide
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James Cordier is the founder of OptionSellers.com, an investment firm specializing in writing commodities options for high net-worth investors seeking outsized returns. James’ market comments are published by several international financial publications and news services including The Wall Street Journal, Reuters World News, Forbes, Bloomberg Television News and CNBC. Michael Gross is an analyst with OptionSellers.com. Mr. Cordier’s and Mr. Gross’ book, The Complete Guide to Option Selling 3rd Edition (McGraw-Hill 2014) is available at bookstores and online retailers now. For more information on managed option selling accounts visit www.OptionSellers.com/Accounts ($250,000 minimum investment)
Price Chart Courtesy of CQG, Inc. Fundamental Charts courtesy of The Hightower Report
***The information in this article has been carefully compiled from sources believed to be reliable, but it’s accuracy is not guaranteed. Use it at your own risk. There is risk of loss in all trading. Past performance is not necessarily indicative of future results. Traders should read The Option Disclosure Statement before trading options and should understand the risks in option trading, including the fact that any time an option is sold, there is an unlimited risk of loss, and when an option is purchased, the entire premium is at risk. In addition, any time an option is purchased or sold, transaction costs including brokerage and exchange fees are at risk. No representation is made that any account is likely to achieve profits or losses similar to those shown, or in any amount. An account may experience different results depending on factors such as timing of trades and account size. Before trading, one should be aware that with the potential for profits, there is also potential for losses, which may be very large. All opinions expressed are current opinions and are subject to change without notice.