Those who invest in the stock market despair when the stock in which they have invested goes down (often really quickly).
Fortunately, this does not happen very often, even if it is enough to make you lose money. But, stocks do not go up very often either.
In fact, 67% of the time stocks do not rise or go down, but they move sideways in a range of prices.
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This sideways movement, for those who invest in shares, means losing time and therefore losing money because the money is tied up in an asset that does not earn.
Those who do trading in options instead, know how to gain from stocks which move sideways in a range of prices.
Calendar Spread: how to make a monthly income by selling options and limiting the risk
In this article, I want to explain a very sophisticated trading technique in options without using very technical terms, so you can understand even if you have no experience in options. If you have experience with these tools, please excuse the simplifications that I have used.
Specifically, I want to talk about Calendar Spread. This technique is really amazing because it allows you to earn even when a title remains substantially on the same price level during a certain period (while with stocks we would not earn anything!).
The basic concept of Calendar Spread is this: earn on a stock that does not move in price, by selling an option and buying another one at the same price, but with different maturities.
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Yes, that is right, with options you can sell, not only buy
The first thing you must understand is that, with options, you can also sell the options that you don’t have. This is called “short”. Or you can collect the money on something that you don’t have. How is it possible?
It is possible. It is as if you say to someone: “Listen, if you want to buy this thing today at this price, you pay me now and I will give it to you later this month.” You receive the payment, and before the end of the month, you go and buy it (at a lower price than he has paid you) and deliver it to him.
If you know about real estate, this resembles the sale of a preliminary contract.
However, you must know that with options you can sell options you don’t have and collect the difference. Then you will see how to do it before the deadline.
Obviously doing this and nothing else is just a crazy risk. What would happen if you sold at 100 and at maturity, the price is 150? You have to put in the difference yourself. It is like that with the “naked short”, or doing “short” without any safety network, you could lose everything you own.
I will never tell you, during my seminars, to do “naked short” options.
The risk is too high and it is not manageable for beginners.
Instead, you must create a safety network and a great way to do it is doing a spread. There are different types but, in this article, we will talk about Calendar Spread.
How does Calendar Spread work?
With a Calendar Spread, you can sell an option and collect the difference. But you cannot limit yourself to do this, otherwise it is not a Calendar, so it’s not a “spread.”
Because the spread is just a system that allows you to sell options you do not have, by limiting the risk. In fact, if you were wrong, and the trade goes against you and the option you have sold increases in value over what you have received, be patient: the option you have bought will increase in value and compensate for the loss of the option you have sold.
Do you understand? With spread – and in general with all the options strategies that I teach in the seminar “Trading in Options”, the first seminar on trading in options in Italy, that started in 2005 – you will have a safety network that protects you from the market moves against you and limits your risks.
For example, say you are in May:
Sell XYZ option expiring in June and gain $ 150
buy option XYZ expiring in November and spend $ 300
result: you spent only $ 150 for an option (to November) instead of $ 300
Now it happens: the title, as you forecasted will not move significantly, then the option you had sold no one wants (do not spend for an option that makes you to pay the market price). You have earned the prize and you will keep it.
The option that you have bought will have dropped in its value in the passage of time (the options have an expiration date and they lose their value as you get closer to the expiration date), we would say that the price would be $ 270 instead of $ 300 as before.
Now you can sell it and get $ 270 which, will be added to the $ 150 you had cashed before gaining a total of $ 420. Minus the $ 300 you had spent to buy, the option is $ 120 profit, which is 40% in less than a month.
Or you can do the same game, by selling the option again with the same price but the price from July (the next month), gaining, let’s say, $ 110 and waiting. If the title does not continue to move (or, rather, to move in a range of very controlled prices), even the second option you have sold will expire priceless and you will keep the $ 110.
And now, you can decide again what to do: sell the option in November, or keep it for another round where you buy the option of August … and so on!
Have you seen what you have done? You have created money with options, thanks to Calendar Spread that allows you to create almost a monthly income. All this while those who own shares of the same title are not gaining anything!
Do you understand the power that options have?
And, if you were wrong. If the title, for some reason decided to go up or down?
In this case, at worst – even if you have time to decide what to do and reduce the losses – will lose all of your initial investment that you remember was $ 300 (option in November purchased) – $ 150 (option of June sold) = $ 150. This is your maximum risk, but you are still likely to be able to contain it a bit more.
Of course, you must do upstream a correct choice for a Calendar Spread ( Blue Chip are ideal, as well as some stock market indices). In general, the “lazy” titles, the ones that traders disdain because nothing ever happens … those are ideal for Calendar Spreads.
That is why I love options! They are an incredibly versatile tool for controlling trading risk and gaining from all market trends and come with leverage. Definitely, you will need a few months of study to begin because they are, in my opinion, the best way to create your financial freedom in trading.
To your financial freedom,