Let’s talk about passive income. I love receiving $2,100 per month in dividends; it’s my favorite part of each month. However, I have $250,000+ invested in the markets.
Passive income takes a lot of capital to generate a decent income stream. Options trading can help you close the gap in your income, but it comes with its own headaches.
There is no doubt that dividends are the end game, but trading long strangles can help you grow your financial foundation much faster while working your 9-5.
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Let’s start with $15,000. We can evaluate leveraging this capital to grow our wealth with long strangles and dividends. Then, we can look at a massive $200,000 portfolio and see how we maneuver our money there. Let’s begin.
$15,000 in a dividend portfolio. It took me about nine months in 2019 and 2020 to accumulate $15,000 in my dividend portfolio. At the time, $15,000 seemed like a huge sum of money because it was a considerable amount of money!
Once you have an emergency fund, you can start investing for income. Income investing is the art of creating a solid income stream with the primary goal of current income.
With my $15,000, I would invest in closed-end funds such as PIMCO Dynamic Fund (PDI, PDO) and Eagle Point Credit (ECC). I would also throw in the mortgage REIT AGNC (AGNC) for good measure.
With these securities, I would average a 12% yield, giving me $150 in monthly income. Does $150 per month sound like a lot of money?
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Let me tell you something: $150 in passive dividend income is huge. You can use this money for anything you want, knowing it will repopulate in your account next month.
If you don’t appreciate $150, how can you love $2,100 in monthly income? And if you don’t appreciate $2,100, how can you love $10,000 in dividends? You have to start somewhere.
Take a look at “Mo’ Money, Mo’ Problems December 2020.” This financial update shows I had $19,000 in my dividend portfolio, earning $122. Less than four years later, I have $312,000, earning $2,100 monthly dividends.
The moral of the story is that dividend investing requires hard work, focus, and patience. However, we can speed up our income generation by learning to trade long strangles.
$15,000 in a long strangle account. Let’s take the same $15,000 and instead use it to trade long strangles. What are long strangles, you ask?
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One long strangle consists of buying one call option and one put option to strangle the stock price. If the stock price moves strongly enough in one direction, you can turn a good profit.
With $15,000 in our account, how much can we hope to earn in monthly strangle income? Using my rule of 15, we can earn $1,000 per month. Let me break this down.
The first rule is to only trade roughly one-third (⅓) of your account at any given time. So that takes our account from $15,000 to $5,000 in playable capital. Why this limit?
If your strangle goes sideways, you want to have the ability to play again. You don’t want to have downtime because you have no money.
With the $5,000, you can expect to earn 20% in profits in a good trade. You can earn much more most of the time. Sometimes, depending on market conditions, you will want to run with a 10% profit. A 20% profit equals roughly $1,000 per month.
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To earn $1,000 every month, you will need to trade three different stocks. I trade long strangles only around quarterly earnings calls; therefore, you will need three stocks (January, February, March, etc.).
Risk of trade and safety of income. What’s the risk profile between income investing and long strangles? The main risk of income investing is capital erosion. This erosion comes from the stock price decreasing over time because it pays too much in dividends over time.
I don’t worry about the erosion of capital, but you may. I focus solely on income. I aim to get all my money back in the form of dividends; once that happens, I am in for an infinite return.
I focus on quality, high-yield products. There is a lot of junk, so you may have to pay a premium for a good closed-end fund like PDI.
The main risk for trading long strangles is you. That’s right; there are no risky investments, only risky investors. That is what my favorite author, Robert Kiyoskai, says.
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Trading long strangles is very emotional. On the day of the earnings call, your portfolio will shoot up in price (or remain flat). If it shoots up, you will have to decide to sell at a profit, knowing that you could double your profit if the stock price keeps rising.
This is where you must exercise discipline and remember your profit goals. Often, I will reach my 20% goal in the first hour of trading. The stock could increase for another 2-3 days, and I could have won much more money.
However, the stock could also retreat just as fast as it rose. You honestly never know. That’s why you must stick to your goals. A winning trade is when you stick to your goals, not if you earn a profit or not.
Building a $200,000 portfolio. A dividend portfolio scales well, meaning you can create a $5 million portfolio and still be sitting pretty.
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On the other hand, a $200,000 options portfolio is far too large. Using my rule of 15, we would be trading with $67,000 to earn a $13,000 monthly income.
It would be a miracle to trade $67,000 in strangles at once. Therefore, you should start selling covered calls and cash-secured puts, which are more capital-intensive.
I wouldn’t go past $15,000 to $20,000 in a long strangle account. As your account grows, you can funnel the profits to your dividend portfolio.
A $200,000 income investing portfolio can generate $2,000/month in dividends at 12%. If you keep your long strangle account on the side, that’s another $1,000 per month.
If you generate $1,000/month on your long strangle account, that is an annual yield of 80% ($12,000/15,000), which is insane. You are playing with fire once you build a portfolio bigger than this. I would rather keep things small and tight than try my hand against the big boys.
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Remember, options trading and day trading pit the little guys versus the big fish. The big fish use automation and trends to choke out the little guys.
When you go for a tiny sliver of the pie, no one really notices. However, once you start trading large amounts, your luck will start to change.
Using leverage to combine techniques. Once you understand the system, you can combine your dividend and options trading portfolio.
Let’s say you have a $50,000 dividend portfolio; you can use leverage of roughly $20,000. Therefore, you can leverage $5,000 to purchase your long strangles while your capital remains invested and paying dividends.
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If you lose, you must sell shares to cover your losses. It would be a good idea to keep $5,000 in a money market fund that you can use in emergencies.
Conclusion. Trading long strangles is the wealth generator, while dividends are the store of capital. Use them both together to grow and keep wealth.
Trading long strangles does not scale well unless you are a professional with access to a large amount of capital and margin. For the rest of us, stay small.
If you can earn 80% on your $15,000 for 20 to 30 years, you will have over $2 million if you invest the profits in dividends.
Therefore, the goal is to remain calm, invest smartly, and stay the course. Trading long strangles is fun but stressful when things don’t go your way.
Dividends are the truest form of passive income for the average person. You should all aim to build a retirement plan consisting of dividends and long strangles. Good Luck!
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