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Is there an options trading strategy that would produce an income of around 8% per year?

Posted by Pete Stolcers on November 12, 2011

Option Trading Question

Is there an options trading strategy that would produce an income of around 8% per year selling FAR OUT THE MONEY PUTS with 3 months duration to expiry? This would be repeated 4 times a year, to produce an 8% return per year. The strategy would be an alternative to investing in a structured product related to a index, where if the index did not fall by more than 45% from a fixed starting level each quarter over a five year period then the 2%/quarter would be paid on the investment. Therfore my question is could options better this return and how? Where the 45% level was breached then the 2%/quarter would not be paid, one breach per year = 6%/year

Option Trading Answer

If 45% is your threshold - yes.

Look at selling the SPY Feb $80 puts @ $.40. Your initial margin requirement (can change if market tanks) is 15% of underlying or $1900 per contract. You will bring in $.40 or $40 on one contract. The $80 strike is 44% OTM (SPY currently at $127) and it is 3 months out. The return it 2.1% ($40/$1900).

The companies offering such products are executing this type of trade.

Given that the edge in this case is only .1% and that you risk losing more than the 2% if the market tanks, I would stick with the structured product you seem to be referencing. Just make sure the firm offering the product is stable and insured.  Man Group just went bankrupt and those guarantees would not mean squat.

Your return will also depend on option implied volatilities. Currently they are high, they won’t always be. That makes the 2%/quarter offer attractive if it is guarenteed over a long period of time. Additionally, you would have to be approved for this strategy by a brokerage firm. Many won’t let you sell naked puts on an index.

Again, make sure the product is insured and the firm offering it is solid. A 45% market decline would be catastrophic. The one from 2008-2009 took down huge firms like Bear Stearns and Lehman.

The nature of your question suggests that you are new to options trading and that also influenced my response. Seasoned option traders can structure better risk/reward scenarios with a little timing and position management. There are hundreds of articles that will get you started in this blog. 

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