Using Weekly Options to Maximize Income Opportunities

For traders focused on generating reliable income from their investment accounts, one of the best strategies is selling puts on stocks that they would be willing to buy at a discount to the current price. Investors can generate annualized returns of 10% to 30% or more simply by selling puts and collecting income as they expire.

As a brief reminder, a put option allows the owner of the contract to sell — or “put” — the stock to the seller at the option’s strike price up to the date when the contract expires. So if you own a put option on Home Depot (NYSE: HD) with a strike price of $75, then you have the right to sell 100 shares of Home Depot to the option seller at a price of $75 per share. This right would become increasingly attractive the lower HD trades. If Home Depot is trading at $65, for example, your ability to sell at $75 would be worth at least $10 per share.

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By selling this put option, we accept the obligation to purchase shares at the strike price. As compensation for taking on the obligation, we are paid a premium (i.e., the price of the put option).

If HD remains above $75, that obligation will not go into effect, because the owner of the put option could sell his stock at a better price in the open market.

Generating Profits From Time Decay

When selling puts, the majority of our income comes from the time decay of the put option. In other words, as the contract nears its expiration date, the value declines for the buyer because there is less time for the underlying stock to drop below, or trade further below, the strike price.

Studies have shown that time decay accelerates as an option nears its expiration date. So, the closer to the expiration date, the faster an option contract loses value for the buyer and the faster income is accumulated for the seller.

Time Decay Chart

Source: TradingMarkets.com

For this reason, I typically like selling puts that are scheduled to expire in the next few weeks, allowing us to maximize the benefit of time decay and generate income faster. The rate of return when selling a short-term put option is typically higher than when using a longer-term contract, giving us more income per unit of time.

Traditional option contracts expire on the third Friday of every month. So with these contracts, there are often periods where we have to choose a contract that expires in a few days, or one that expires in four to six weeks depending on where we are in the month.

Traditional option contracts expire on the third Friday of every month. So with these contracts, there are often periods where we have to choose a contract that expires in a few days, or one that expires in four to six weeks depending on where we are in the month.

Selling Puts on Weekly Options

For many of the more liquid stocks, option exchanges are now offering weekly options. These contracts expire each week, giving traders more options than just the monthly contracts.

As a general rule, these contracts are offered two to three weeks out, so if you are looking at an option chain on a particular Tuesday, you would be able to see contracts that expire on Friday, contracts that expire a week from Friday, and possibly contracts that expire two weeks from Friday.

A wider assortment of available contracts gives us more opportunities to set up trades with better rates of return for the time period. The goal here is to find a contract that allows us to maximize the time decay while still minimizing our trading expenses.

The disadvantage of using very short-term contracts is that our transaction costs can be higher when selling puts that expire in a short amount of time. We must make sure we have enough income built into each position to overcome the commissions and slippage. Thankfully, with the competitive online brokerage industry driving commissions to very low levels, our transaction costs should be relatively cheap.

The other concern is the liquidity of these weekly options. You want to make sure that you are getting an attractive price and that you can enter (and exit, if necessary) in an efficient manner.

One helpful way to evaluate the liquidity for these weekly options is to look at the bid/ask spread — or the difference between the bid price and the ask price of the contract. If the two prices are relatively close, this is usually an indication of an efficient market that will give you a competitive price. But if the spread is wide, you are less likely to get a fair price when selling your put option.

We’ll discuss liquidity in another article soon. In the meantime, consider selling puts on weekly options to generate higher rates of return from your investment capital.

Note: By using this same income-generating strategy, my colleague, Amber Hestla, has helped her Income Trader members earn $6,000… $19,500… even $150,000 this year alone. Click here to learn how you could do the same.