A great way of making passive residual income trading options that has an even lower risk than selling naked puts and covered calls is a strategy known as the spread.
There are two main types of spreads that you as an investor can use to make money with oprions.
Overview
If you read my previous post you know that the naked put strategy involves selling a put option on a particular stock. With this strategy you are getting paid for the "possibility" of owning a stock. Your risk here is that you may have to buy the stock at some point in the future if the stock dips below the strike price of the put option you sold.
For example if you sold a put option on XYZ stock at the $25 strike price and the stock drops to $19 at expiration of the option, you would have to receive the stock at $25 even thought the market price is $25. Buy selling the put option you are on the hook to purchase the stock no matter what the stock drops to. Even if the stock dropped to $0 you would still have to buy it at $25 because that is the contract you created when you sold the put option.
So as you can imagine most brokerages would not let you sell more options than the cash you have in your account. You can offset this risk by buying a put option when you sell your put option. This is how a spread works. You sell one type of option on a stock at one strike price and simultaneously buy another option on the same stock at another strike price.
Debit Spread
With a Debit Spread the option you sell is worth less than the option you buy so it actually costs you to enter into this position.
For example you sold the $25 put option for $1 and then you bought the $26 put option for $1.6 so you would have a net cost of $0.6 ($1.6 - $1.0) per contract or $60.
I won't get into Debit spreads here because I don't like them or recommend them. I like to receive my money upfront and this blog is about making passive residual income. Credit spreads accomplish that goal.
Credit Spread
With credit spreads, the option you sell is worth more than the option you bought so you receive a credit upfront.
For example, you sold the $25 put option for $1 per contract but then you bought the $23 put option for $0.4 per contract so you have a credit of $0.6. The spread between the two options is the difference in the strike price so $2 ($25-$23).
Note: The spread determines your cost to get into this position and now has nothing to do with the actual price of the stock.
To purchase 10 of these spreads you would only need to have $2,000 (10 contracts x 100 shares for each contract x $2 spread) - the credit you received $600 (10 contracts x 100 shares for each contract x $0.6 credit) = $1400
The benefit here is that you are investing $1,400 and you are already locked in to make $600 as long as the stock stays above $25. That is a return of 42%!!
If you were just selling the put option you would need to have $25,000 ($12,500 if you have a margin account) cash in your account to take ownership of the shares. In this example you only need $1400 and your maximum risk is $1400 no matter how low the stock goes.
I used this Credit Spread strategy to see "what is the minimum I need to get started in stock market investing." I took a brokerage account with $258 and in 6months turned it into $1329 buy selling credit spreads.
With the credit spread strategy you can now get involved with high priced stocks like google that have traded as high as $600 per share!
I like credit spreads because my profits are locked in up front and my risk is limited. Once you set up this strategy all you have to do is wait for the options to expire.
Learn more about options trading strategies and other ways to make passive residual income visit http://bestresidualincomestrategies.com/category/passive-income/stock-market
