Over the years, I’ve tried many common side hustles: eBooks, tutoring, teaching evening classes, dividend growth investing, selling on ebay, even Amazon Mechanical Turk. I had only modest success until I finally stumbled upon options trading in the stock market. It combines my knowledge and passion for stock trading with the concept of OPM (other people’s money), resulting in a high dollar-per-hour outcome.
What are options?
There’s two kinds of options:
- Put Option – the put option owner has the right to sell 100 shares of a stock to the option seller at a certain price within a certain time, often a month
- Call Option – the call option owner has the right to buy 100 shares of a stock from the option seller at a certain price within a certain time, often a month.
Let’s use a real example of a trade I made on February 19th, 2020:
Sold 1 UPS April 17th, 2020 Put. Premium: $5.85 per share. Execution Price: $110.
My total potential income is $585 (100 shares X $5.85 premium per share) excluding any commission I pay to my brokerage. My total gross money on the line (risk) is $11,000 (100 shares X $110 execution price). Factoring in the fact that I got paid $585, my total net money on the line is $10,415 ($11,000 – $585). The most beautiful thing is that I get paid today with no cash outflow.
Simple enough so far, right? But what about the risk of the option executing? And doesn’t this tie up my money so I can’t invest in other things?
The magic: rolling options
April 17th came around and sure enough, UPS was trading well below $110 per share. It seemed like I was going to be the lucky new owner of 100 shares of UPS…but I wasn’t.
Instead, I “rolled” the put out another four months. This means I made the following trades:
Bought 1 UPS 110 April 17th, 2020 Put. Cost: $6.47 per share.
Sold 1 UPS August 21st, 2020 Put. Premium: $12.82 per share. Execution Price: $110.
The net effect of this trade is that I generated $635 ($1,282 – $647) and have an obligation to buy 100 shares of UPS at $110 per share for another four months. My net risk is now $9,780 ($11,000 original risk – $585 income from April put – $635 net income from August put).
What will I do if UPS is still trading below $110 in August? If I don’t want to own the stock for the long term, I will roll the put again. The lower UPS is trading, the less premium I will collect when I roll the put, but this is just a side hustle and I am not relying on this income. Besides…all of my money is working for me in other investments anyway. These trade were actually what is known as “naked” put options.
Even more magical: selling puts against margin
This UPS put requires me to be capable of buying 100 shares of UPS at $110 per share, but I don’t actually have cash backing this trade. This trade is backed by the value of my portfolio of stocks (collateral) at my broker and my ability to access margin from the broker. I don’t actually take on any margin debt, so I don’t pay any margin interest. As long as I have a very low exposure to naked puts relative to my portfolio value, I personally feel safe.
The rule of thumb I follow is to limit my naked put exposure to 25% of my portfolio value. An example $20,000 portfolio would be:
$20,000 invested in an index fund such as Vanguard's VTI which tracks the total US stock market. Another $5,000 in exposure to naked put options.
Margin can increase returns or quickly destroy a portfolio. The way I use it is reminiscent of owning a rental house, except it’s more like 80% equity and 20% debt. As magical as margin and debt seem to be, I always remain vigilant against my own potential to be greedy and overextend myself.
Rinse and repeat
My UPS trades generated net premium of about $1,200 over six months, or about $200 per month. It required $11,000 of risk exposure. I can very loosely extrapolate those numbers and say, for example, if I want to generate $500 per month then I need to be able to take on about $28,000 in risk. The monthly income will fluctuate based on stock prices and how much volatility there is in the market (volatility drives up option premium that sellers can make), but it can be a consistent income generator.
I believe that as long as my puts are sold against high quality blue chip companies (or better yet, index funds), I don’t have to spend a lot of time on this side hustle. I only sell puts against companies I want to own at prices I am happy to buy the shares at. This helps me sleep well at night. Time wears down the value of the puts. This makes the income mostly passive. The main limitation is the amount of puts my portfolio can sustain.
This is certainly a side hustle where the saying “It takes money to make money” is true. However, I think anyone who is looking to generate extra cash flow from their portfolio and has a genuine interest in the stock market should learn more about options trading. And there is far more to learn, especially about the risks involved.
I have to add the normal disclaimer that I am not a professional investor, I just do this for fun and freedom. I also recommend you speak to your investment advisor before you make new kinds of trades. Finally, I am not recommending a particular trade. I am long UPS.
If you want to learn more, please take a look at my options trading eBook where I dive further into my philosophy and trading strategies.