It's March 2009 and, almost, the entire world is in recession. But if you've got a bit of spare cash around, you can earn some seriously good money by trading options. As I explained in Trading for Dummies, options have a time value in their cost structure. The idea, in a flat or declining market, is to sell call options (the right to buy). To take advantage of this (time value) the strategy is sell-near and buy-far - a spread. Listed below are trading tips that I have used successfully.



The time value in an option contract will drop dramatically in the last 3-4 weeks until its expiry, for two reasons. Mostly it is because it is easier to predict the share price as it gets closer to the expiry date and as Black, Scholes, and Merton told us, we need to compare the investment with risk-free money (interest rates) opportunities. But a months? worth of interest from the bank isn't going to reap too much.

Simply selling a call option to take advantage of the time value is risky. It will leave you wide-open if the share picks up dramatically. So you need to purchase some insurance. This means, you need to buy a more stable call option to cover you in the event of the share price spiking. Contracts which have an expiry date further away will hold their value better than near-expiry options, as stated in the previous paragraph. This is the idea of sell-near, buy-far.

But there are some pre-requisites to doing this. Obviously you will need to have an options trading account and, to do it seriously, have at least $15,000 in your account.

Rules to Spread Trading Call Options

1.Pick the Right Share

Choose a large share, preferably an index, which has liquidity in its options contracts, ie many people trading these particular options. I have used SPY or DIA (US Stocks) as they have great liquidity.

2.The Sell Option

Choose an out-of-the-money strike price which you would expect the share price to not reach before the expiry date. Use a probability calculator to check your assumption. I prefer a simple calculator that you can modify the values of.

Try: http://www.otrader.com.au/options_probability_calculator.asp

If the probability is less than 20%, it's a goer! This is the option you will sell.

3.The Buy Option

Find an option that is further out-of-the-money and a month after the one that you have chosen in rule two. Make sure this option's value is less than the value of the option in rule 2. This is your insurance option, you will buy this option

4.Limit your Loss

A good trader knows when to stop. Set yourself a loss limit. You won't always win with this strategy, so be prepared to cut your losses when you have to.

5.Take your Profit

If the share price falls dramatically don't be afraid to sell out to get your profit. A profit isn't a profit until it's realised. If you're holding on to an option for a week until expiry when it's only worth 5 cents, then you're wasting your money. Get out and re-trade!