Do you want to become an options trader but have limited resources? In this case, I recommend trading long strangles for passive income.
Trading long strangles differs from selling covered calls because you buy options contracts. It is much cheaper to purchase a call than to sell a covered call.
Today, I want to walk you through how to trade long strangles and make consistent passive income starting with a small amount of cash. Let’s begin.
Let’s Get Started with Index Funds
Building your options trading portfolio. I like to separate my options trading portfolio from my other investing accounts—I recommend you do the same.
Your options trading account will have violent swings upwards and downwards; that is the nature of options trading. Determining your overall portfolio fluctuations is tough when you have options contracts in the mix; hence, I separate them from dividend stocks.
How much do you need to start? I use my rule of 15 to determine how much I need to start. Take how much monthly income you desire and multiply it by 15.
For example, let’s say you want to earn $200 monthly from options trading. You should create a portfolio with $3,000.
I use young, volatile stocks with a price range of $10-$15. These stocks have crazy earnings calls that can shoot the stock up or down violently—which we need.
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Currently, my favorite stock to trade is Rivian (RIVN). Many of my other stocks have outgrown my strategy—for example, Palatir (PLTR), which is now over $70.
Getting started in the options market. You need to be a level one trader to sell covered calls and cash-secured puts; however, you’ll need a higher level to trade long strangles.
I became a level three trader on Charles Schwab to trade long strangeles. There is more risk when buying options contracts, primarily if you use margin.
Imagine if someone borrowed $3,000 to purchase 15 call options. The price reverses course and heads downward fast. They immediately lost all of that money. Things are real on these streets.
We will save $3,000 first and then become a level three trader. Once we do that, it is time to review the options chain.
Today, December 12th, 2024, Rivian (RIVN) sells for $13.73. We want to sell long strangles one month away (at a minimum). We also want to ensure it includes an earnings call.
Looking at the January 10 options chain, we want to “strangle” the share price with a put and a call. Therefore, we can purchase a put at the $13 strike price and a call at $14.50.
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The put will cost us $70, and the call will cost $76. The total for one strangle will be $146. Now, we need to talk about creating a successful trade.
How to succeed at trading long strangles. I aim to earn a 10% return on my strangles. I would aim for a $14 price increase in the case above.
The tricky part about long strangles is that you need a significant price movement to earn a profit. I like to say you need at least a 10% share price move in either direction.
You are also fighting the time decay element of owning options. Each day you own an option, it is losing money. As you get within two weeks of the expiration, you are hemorrhaging money.
However, volatility can play into your favor as well. Say you purchase your put and call for the above prices. If the stock’s price goes wild (usually upward), the volatility will spike the cost of your options.
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Therefore, sometimes you can make your profits before earnings happen because people anticipate significant price action.
All of this is to say that you must be vigilant. If things aren’t going your way, sell your contracts and relax. If you stay crisp, you’ll succeed more times than not.
Why trade long strangles? What makes trading long strangles different from other options strategies? Strangles give you immediate insurance against catastrophic loss.
If you set your parameters correctly, including the expiration date, earnings call, and strike prices, you shouldn’t lose too much on a “bad” trade.
The 100-Year Mortgage in Coming
The worst thing that can happen to a long strangle is that the share price stays flat, and you “time decay” your way into oblivion.
I solve the time decay issue by purchasing a strangle one week before earnings, but setting the expiration 30-60 past earnings. Remember, time decay truly picks up in the final two weeks.
Sometimes, you will get a strong move in one direction, giving you a small profit (say 5%). Things get tricky here; you must use your experience and judgment to make a good play.
You can sell everything and make a small profit or wait until the next day. If the trend continues in the right direction, you stand to make big bucks. If it reverses, the stock price will end up flat again.
As you play around with these scenarios, you’ll understand that you have a lot of control over the situation. Most of the time, fear and greed make you lose.
Where Should You Save Your Emergency Fund?
Scaling your plays. We want to earn $200/month in options income, right? One strangle costs $146, so we must scale up to earn our target.
We must invest $2,000 in strangles to earn our target of $200 (using the 10% rule). That means we should purchase roughly 14 puts and 14 calls.
Things will definitely get exciting when playing with more considerable sums of money; however, the rules remain the same.
If the market is on an overall upswing, your earnings call will likely go hyper-positive. But, it is not a guarantee.
However, if the market has been neutral to the earnings season, you can bet your earnings call will be flat. That’s why it is essential to follow your individual stocks and the overall mood of the market.
America Will Never Let You Rest
Playing with fire. The best way to trade long strangles is to assume you will lose everything you enter into the markets, like at a casino.
Whatever money you put into the options market, consider it a loss from the beginning. That way, you will be happy if you recover even 70-80% of your money.
If you save $3,000 in your options trading portfolio but only feel comfortable trading $300 at a time, then do that.
Your emotions will dictate how much you are willing to trade. Winning a few times will give you the confidence to play with bigger numbers, but don’t pressure yourself.
New Year’s Passive Income Resolution 2024
Conclusion. Ultimately, you are the only person who will lose sleep over your trades. No one will tell you to enter or exit a trade. No one will tell you to purchase $200 or $2,000 worth of contracts.
You are in complete control of everything except the share price. Trading long strangeles is fun when you play with small numbers.
However, it can be pretty daunting when you get into bigger numbers. At one point, I was trading $8,000 at once, and I won $4,000 in one trade.
Now, I am much more chill. I did the big numbers, but small numbers make me happier. I like the balance of small numbers.
Trading long strangles is not for everyone. In fact, 95% of the population should stay far away from these products because it takes immense self-control and self-awareness.
For those 5%, take a look at long strangles. They offer built-in protections, to coincide with your rulesets. It’s a fun trade if you keep the numbers small. I believe in you. Good Luck!
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