It is another end of the month, and time for me to start capturing the amount of cash flow I have collected using options.
Today's month, I am going to talk about collecting cash flow using vertical options.
Now, what I love about vertical options is the fact that anyone with a small capital can start with this strategy.
Ready?
Let's dive in.
What is a Vertical Spread
Vertical spreads, also known as "Bull Put Spread" or "Bull Call Spread".
Bull Put spread is a bullish strategy whereas Bull Call Spread is a bearish strategy.
Well, how does it work? Let's talk about a Bull Put Spread first.
Here's an example of a BPS that I did.
- Sell 2 Put META 120 @ $1.53, 21 Oct 22
- Buy 2 Put META 115 @ $0.84, 21 Oct 22
What exactly am I doing here?
Well, I sold 2 put options and collected $153 x 2 = $306. I used a portion of $306 to buy 2 put options worth $84 x 2 = $168.
Effectively, I have collected $138.
How To Make Money With Vertical Spreads
What is the game here?
Surely, I cannot be that easy that I simply collected $138 - correct?
Well, it is not that simple.
Remember that we are selling options here. So we want to sell high and buy low.
When we sell the vertical option and collected $138. We want to ideally buy back the vertical option at a lower price and collect the difference.
Remember - sell high, buy low. Ideally, we want to buy the vertical option back at $0 - allowing us to collect the $138.
So how do we do that?
Well, as long as the share price is above the share price of sell put at the end of expiry, you would be able to collect premium.
For example, at the end of 21 Oct 22, META share price was at $130.
Since my sell put strike price is 120 - I did not have to buy back the sell put option and therefore collected the entire option premium.
What is the risk of vertical spreads?
The best part of vertical spreads, is that the risk is limited. Therefore, unlike naked sell put options, they use up lesser margin as well.
So what is the risk here?
Well, here's the formula:
Risk = (Sell Put Strike - Buy Put Strike) X 100 X No. of Option Contracts - Premium Collected
Therefore, the total risk here is:
Risk = (120 - 115) x 100 x 2 - $138 = $862
When putting on this vertical spread, the maximum risk I have is $862. This means even if META went down to zero, the most I can ever lose is $862. The maximum reward, however, is limited to the amount of premium I have collected, which is $138.
Why Risk $862 to make $138
Many people who are new to options tend to ask this question.
Why would anyone in the right mind take the risk of $862 to make a $138. Shouldn't it be the other case?
Well, there is one thing that was not considered.
Probability of trade success.
Whenever I put on an options trade, I stack the odds massively into my favor. This means the chances of me winning is close to 90%. This means the chances of me collected the option premium is high.
Furthermore, to lose $862, the share price has to tank considerably. This means that the share price has to fall below the strike price of the buy put.
This is why I am willing to take this trade.
Rinse and Repeat
With the current conditions of the market, it provides many opportunities to take these high probability trade set-up, allowing us to collect these cash flow over time - and for myself, collecting over $2,000 in the month of Oct.
I will share more on how to stack the odds greatly in your favor in the future in future articles as well.
If you are interested to learn more about generating cash flow, I would like to invite you to register interest in my upcoming Options Cash Flow course.