Our 40s can be a fantastic time. We could be married, our kids could be older and more self-sufficient, we may have climbed the corporate ladder, or we may be in a two-income household.
Most importantly, we may have some time to ourselves. We can use this time to build a decent-seized options trading portfolio. However, the first thing we need to do is determine our risk tolerance.
The risks of taking risks. There is no doubt about it: options trading can be risky. There is literally no rhyme or reason to the stock market.
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The general trend is for the market to rise over time, which benefits long-term investors. However, short-term (or “swing”) traders have a timeline for taking profits.
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Indeed, when you “buy” options, you own a ticking time bomb that could destroy your wealth. Therefore, we must be intentional with every move we make.
The best way to limit risk in our 40s is to determine the amount of money we can lose and still go to sleep at night.
This number may stay the same over time. If my number is $2,000, I can create an options portfolio around this.
Let’s say you have about one hour daily to dedicate to options trading in your 40s. We will say that our sleep well at night number is $2,000. From there, let’s create a strategy to build wealth and generate income in our 40s.
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What size portfolio? If your sleep at night amount is $2,000, you want to have a portfolio at least five times as big. In this case, we will build a portfolio of $10,000.
Now, we have two choices for formulating this portfolio: we can use the options wheel strategy or trade long strangles.
Of course, there are dozens and dozens more options strategies, but these are my two go-to methods. For a list of options trading strategies, read “The Options Playbook.”
With our $10,000 options portfolio in tow, let’s build a plan to generate income or build wealth. What’s the difference?
Building wealth is the process of compounding your investments. Therefore, the goal of your options portfolio is to grow from $10,000 to $100,000.
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You don’t need to take more risk; just reinvest your winnings into other high-yielding products or safer bonds. The more you earn, the faster you compound.
Generating income means you take some winnings off the table. You may stash the cash in a high-yield savings account or certificate of deposit.
However, you are generally not purely trying to get a bigger portfolio. You will use the proceeds to help create a better life today.
The option wheel strategy. With the options wheel strategy, you will not be using leverage. You will sell covered calls and cash-secured puts in an endless loop.
The good part is that you don’t necessarily have to worry about losing money as much as timing your trade. There could be a situation where you are upside down on your covered calls. This means your cost basis is lower than the strike price you can set.
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But you don’t lose money unless you position yourself to lose money. This method can produce good results if you take the long, slow road to wealth. It’s reasonable to earn 40% annual returns on your income if you trade mildly volatile stocks.
Trading long strangles. I prefer to trade long strangles if I have $2,000 to spare. Trading a long strangle involves “buying” one call and one put.
The strike price of the call is above the stock’s price, and the strike price of the put is below the stock’s price. For example, if Rivian (RIVN) is trading for $18, I would set the call for $19 and the put for $17.
I could win if the stock price moves in any direction. However, there is one massive caveat. For you to take profits, the stock price needs to move violently in one direction.
I’d say the price needs to move 10% in one direction for a winning trade. Remember, when you buy an option, the clock immediately destroys its worth.
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As your option’s price decays, you need a greater price swing to earn a profit. You will get the hang of it.
Using leverage. The best part of trading long strangles versus the options wheel is that you can use leverage. With the options wheel, you need your hard-earned cash to purchase stocks or keep money on hand for cash-secured puts.
With the long-strangle strategy, I can invest my money in dividend stocks or index funds to grow my wealth organically. Then, I can borrow money against my portfolio to make my strangles. Let’s examine this technique.
The first part is deciding how to structure your portfolio. In this case, let’s use a closed-end fund like the PIMCO Dynamic Fund (PDI), which currently yields 14%.
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Since my sleep-at-night number is $2,000, I would keep $2,000 in a money market fund and invest the other $8,000 in PDI, yielding me $93 in monthly dividends.
Once a quarter, Rivian (RIVN) holds a press release called an earning call. This is the most predictably volatile moment for any stock. We need volatility for our strangles to win.
Based on today’s prices, I can purchase one $19 strike price call for $151 and one $16 strike price put for $121. Therefore, I would safely purchase five of each for a total of $1,360. That’s well in my $2,000 sleep-at-night amount.
I can set this play up about one week before earnings and wait for the fireworks. If things go as planned, I can make 20% to 30% off my $1,360 investment.
I’ve made much more than this, but I don’t get greedy. I typically don’t hold the options past the earnings call date. Once I go green, I get out. However, sometimes, holding for extended periods can be a winning combo.
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When you add this little boost of income, plus the other PDI investment, you can build a nice portfolio quickly. You could make $1,120 in annual dividends and perhaps $2,000 in options wins.
That totals $3,120 on top of your $10,000 portfolio. You will generate more dividend income if you reinvest your dividends and options winnings into the closed-end fund.
Conclusion. Your 40s are a transitional phase. Hopefully, you are moving away from the “worker bee” mentality and into the “wealth-building” one.
You should have more time and disposable income to invest in the markets. The options market can be quite lucrative; however, it is all about controlling greed and fear.
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If you are losing sleep at night, your bets are too big. If this is the case, stick with the options wheel strategy or reduce your sleep well at night number.
Remember, a high-yield savings account pays you 5% of your cash. If you make more than this, you are winning. You can earn 20 to 30% using the options wheel.
You can earn much more by trading long strangles. If you increase your sleep at night number to $5,000, you can make 50% to 70% annual returns. However, with tremendous rewards comes significant risk.
Ensure you examine your risk appetite and sleep at night number. Sleeping well is the most critical part of trading options in your 40s. Good Luck!
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