If we sell a call option (I'll explain what a call option is in this lesson), we win if the stock goes down or sideways, but we can also position our trade to work if the stock goes up only a little.
When you buy a stock you make money only when it goes up. If it goes down you lose money. And if it just sits there like a lazy dog, your money is just tied up, unless you get dividends. Normally if a stock you own moves sideways, it is called "dead money" because not only are you not making money, but you are not making the interest you could be making if the money was invested somewhere else. You lose twice.
But what if you could come out ahead no matter which way the stock went? Interested?
Let's use Google for our example. Let's say Google is at $300. If you think Google is going up you can buy it for $300 a share. Or you can buy a "Call" option for $30. A "Call" option is the option you buy when you think a stock will go up in value. The other type of option is the "Put" option, which goes up in value if the stock goes down.
By buying a Call, we need GOOG to move up. Instead of that let's sell some options.
We can sell a "Put" option. This means we will sell an option to someone who thinks GOOG is going down. Let's sell the put at the $250 strike price for $2. This mean we get $200 for the option and the option will expire worthless if GOOG stays above $250. We think GOOG is going up so we are fine with that. The option will expire in 30 days.
Now if GOOG goes up, or sideways, and even down to $250 we still make money. This type of strategy works great when stocks are trending, meaning they continue to go in the same direction.
But sometimes we don't know which way a stock is going to go. What do we do then?
We can sell Calls and Puts at the same time.
Ok so GOOG is at $300. In 30 days we think GOOG is going to move up and down but we don't know where it will stop exactly. But are pretty sure it is going to be in a $100 range, so either up to $350 or down to $250. We can figure this out by technical analysis or using statistics and probabilities. (I'll show you more in a future lesson.)
So what we do in this case is we sell the $240 Put for $1.50 and we sell the $360 Call for $1.25. So we get a total of $2.75 or $275. Now as long as GOOG stays in between $240 and $360 we profit on both sides. Where it gets tricky is when GOOG breaks out of the range. That is the only way you can get hurt and if that happens you have to either adjust the trade, or exit..
Considering the fact that stocks move in a sideways direction about 75% of the time, this strategy can make you some nice dough on a stock that is just bouncing up and down in its range. I personally wouldn't do this strategy on GOOG because it moves up and down too much, but it is easily done on indexes and ETFs.
In fact, this is one of the strategies we use every month. It's called the Iron Condor. We do basically what I described above but add in some risk and loss management. We don't win every month, but we limit our losses in the months we do lose. In a future lesson I will walk you through an actual Iron Condor trade that I have done.
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