6 Types of FIRE movement

Retirement Sign

FIRE movement is a trend among young people that’s growing in popularity thanks to its goal of retiring early. FIRE stands for Financial Independence Retire Early. The concept is based on following a very disciplined and aggressive saving and investing strategy. This continuous cycle of saving and investing over time will build a big enough nest egg that will give you the freedom to leave the workforce once and for all.

FIRE movement is not a new concept. It was first introduced in the book Your Money or Your Life written by Vicki Robin and Joe Dominguez in 1992. The main concept of their book is that most of us go through life exchanging time for money without thinking much about it.

While the FIRE concepts were created in the early 90s it took another 15 or so years for it to gain popularity. The great recession that saw 10 million+ people lose their jobs played a big part in it. A big portion of the people affected were the millennials who were barely out of school and very early in their careers. Along came quite a few blogs that focused on FIRE and millennials scarred by student loans and the thought of working till 65 while constantly fearing for their jobs made an ideal place for the FIRE movement to take off.

People who follow the FIRE movement get a bad name for being very cheap. What’s the point in saving a big chunk of your money and basically not enjoying life today in hopes of saving enough to retire early? What kind of “retired” life can you have after living with the bare minimum for so many years? There is no one size fits all for the FIRE movement. If you are planning to go down the FIRE path, you have to know that there are different types of FIRE.

There are definitely similarities between the different types of FIRE. You have to save a portion of your salary and invest it and grow to a point where the amount you earn from it can replace your salary. A simplified version of looking at it would be how do you plan on living once you retire and how quickly you want to get there, that would determine what type of FIRE is ideal for you.

How much do you need to save?

Anything I have watched, read or heard related to FIRE talk about the 4% rule and this seems to be universally accepted as a rule for everyone who considers FIRE-ing.

The amount you need to have saved and invested should be 25x your annual spending. The annual spending you have planned for your early retirement. Let’s say you plan on living in a budget of $50K during retirement. Then you will have to save 25x $50K which would come up to $1.25 million.

The idea is that the money you have invested will grow every year. If you are to withdraw 4% of your investments every year, the invested balance will not come down and should let you live your early retirement life forever.

Regular FIRE

This is the plain vanilla cookie cutter version of FIRE. This is the version where you maintain your current or working life lifestyle. If you live on $60K a year then you would need to save $1.5 million to reach the 4% safe withdrawal rate. I have seen on other sites that regular FIRE should have yearly expenses between $40K – $100K a year. I think the yearly expense is less important for regular FIRE. What’s important to you is probably maintaining your current standard of living and having freedom.

Lean FIRE

Lean fire is the bare bones version. This is where we start focusing on yearly expenses. For people who know nothing about the FIRE movement, this is the rice and beans or ramen noodles for every meal type of early retirement. That sounds a bit harsh but there is some truth to it. The type of FIRE is suited for people who plan to live a frugal and minimalist lifestyle. Commonly, Lean FIRE is for folks who can live on a $40,000 budget every year. 

Regardless of the type of FIRE you are aiming for you can expect pros and cons with it.

Pros of Lean FIRE

  1. Quickest way to FIRE
  2. Freedom earlier

Cons of Lean FIRE

  1. Living in a small place
  2. Limited to living in a low cost area
  3. Constantly make spending sacrifices

Fat FIRE

Fat FIRE is for the folks who want to live on a $100k salary after they become financially independent. you will need a bigger nest egg to achieve this. Using the 4% rule, you will need to have $2.5 million saved. As you can expect this will take longer than Lean FIRE and regular FIRE to reach.

Pros of Fat FIRE

  1. Few worries about spending
  2. Travel when you want to
  3. Feeling of safety with the money invested

Cons of Fat FIRE

  1. Takes longer to achieve

Barista FIRE

The types of FIRE listed so far is more of a “retired” version. Typically, you reach your FIRE savings amount and are done working. This is a great in between fully FIRE and working a job you really hate. In this one you have a part time job that covers some of the expenses and the remaining is covered by your investments. The common part time job is getting a barista gig at a coffee shop.

How would this work? Let’s say you are aiming for lean FIRE and need 40K every year. You have saved up $750K so far but really need $1 million saved up to follow the 4% rule properly. Using the 4% rule you can withdraw $30K. But you will still need another $10K to cover your frugal lifestyle. This 10K could come from the barista job or whatever part time job you get.

Pros of Barista FIRE

  1. Quicker way to reach FIRE
  2. Leaving a job you hate quicker

Cons of Barista FIRE

  1. Finding a part time job that pays well
  2. Don’t have full control of your schedule usually

Coast FIRE

Coast fire all about future planning. You figured out your financial independence amount at a very early stage. The goal is to have a high savings rate early in your career and have it reach a point where you don’t have to save anymore. The invested money will grow into the total amount you need to FIRE eventually. There is no specific amount for this. It could be considered as a sub category lean or fat. Coast FIRE is the method you use to reach Fire Status and LEAN, regular or fat is more related to your lifestyle

Pros of Coast FIRE

  1. Time does a lot of the work

Cons of Coast FIRE

  1. High savings rate and amount at young age when your salary is probably pretty low

MoFIRE

This is my favorite. MoFIRE stands for morbidly obese FIRE. In terms of spending limits I’m not really sure if there is a specific number for yearly expenses. If fatfire is at $100k this should be considerably more. It could be any number as long as it’s very high. Let’s say it’s $250K. How about doubling or tripling your current lifestyle? This should be everyone’s life goal.

Pros of MoFIRE

  1. No spending sacrifice at all
  2. Same as Fat FIRE and much better

Cons of MoFIRE

  1. Takes a long time to reach. Perhaps impossible.
  2. I can’t think of anything else

4 Stocks for Monthly Income for 2021

Alarm Clock with three stacks of coins

You can find the list for 2022 here.

It’s pretty common for people to look into dividend stocks if they’re looking for monthly income. This is especially true for people who are retired, who are nearing retirement and the early retirement FIRE movement folks.

Dividends are the portion of the profits that’s paid out to its shareholders on a regular basis. Buying stock in the company makes you a shareholder and investor. Shareholders and investors used interchangeably a lot. The dividend amount and how often they pay are usually determined by the company and the majority of the companies pay every three months.

This is great but what if you use dividends as your primary source of income to live everyday. Or you’re looking for some passive income every month. This is where monthly income from dividend stocks comes into play.

Here’s a list of 4 companies that pay dividends every month.

  1. Realty Income (O)
  2. Main Street Capital (MAIN)
  3. SL Green Realty (SLG)
  4. STAG Industrial (STAG)

There are more companies that give a monthly income but some lack consistency, some don’t have a long history of paying dividends. The criteria I used to filter them down are –

  1. Companies paid dividends for around 10 years or more.
  2. No missed dividend payment during the 10 year or more time frame.
  3. Increased dividend payments over time.

Companies fitting these criteria gives a certain level of confidence as it shows longevity, consistency and commitment to their track record. This is particularly important because we have no control over the dividend policy of the company. You have to use the information that’s available online to determine whether these companies deserve your investment.

Most of the companies in this list are REITs (Real Estate Investment Trust). REITs are companies that own real estate properties and produce income by renting or leasing out their property.

The business model of these REITs on a very basic level is very much like you buying a house and renting out to make a small profit after paying your mortgage, property tax and maintenance. On a larger scale these are big corporations that have access to a lot of money and can buy big commercial properties and rent them out to other large corporations for lease agreements that are in excess of 5 years. 

Slight difference would be that they specialize in long term leases under a net lease agreement.

Here is a little bit more information about each of these companies.

1. Realty Income (O)

Realty Income is a REIT that focuses on commercial properties under a long term net lease agreement. A net lease agreement means that the renter is responsible for paying a portion or all the property taxes, maintenance costs etc. This is like having a rental property without any of the tenants problems.

Realty Income is so proud of paying dividends on a monthly basis that their company tagline is “ The Monthly Dividend Company”. Realty Income definitely has their investors in mind and know that people are mostly buying their stock for the monthly dividend. Their home page provides details on how the stock has performed since being listed in NYSE and how long they have paid dividends. I found this on Realty Income home page.

Dividend Metrics

  • Current Dividend Yield: 4.8%
  • Dividend per share monthly: $0.235
  • Dividend per share yearly: $2.81
  • 10 year Dividend Growth rate: 4.9%
  • Years paying dividend with increases: 28

Looking back to the last 10 years they have raised their dividend by an average of 4.9% on a yearly basis. Easy way to look at it is if you got $100 in dividends the first year, the second year you received close to $105 in dividends. The third year would be 5% on top of the $105 and so on.This is pretty good in my opinion since it’s above the regular inflation rate of about 2%.

Seeing an average of 4.9% annual dividend growth rate might seem very small and unimpressive because well it’s just 4.9%. Monthly dividend per share for Realty Income in 2010 was $0.144, 2015 was $0.191 and 2020 was $0.234. 

From 2010 to 2015 – an increase of 32.6% in dividend payout over a span of 5 years. From 2010 to 2020 – a massive increase of 62.5%. 

What’s really important to understand from this is that you can only enjoy these massive dividend increases if you have been invested in the stocks for 5 or 10 years. The 5 year and 10 year difference also demonstrates the need for being invested in dividend stock for a long period of time. The longer you are invested in a stock that raises their dividends regularly, the better you will do over time. 

Not being able to see the impact of what a 5% annual growth rate is probably the reason why it’s difficult for people to grasp onto the concept of the power of compounding, but that’s a topic for another day.

2. Main Street Capital (MAIN)

This is the only company on the list that is not a REIT. Main Street Capital is an investment firm that provides long term debt and financing to lower middle market and middle market companies. That’s just a fancy way of saying providing loans to companies with annual sales up to $1 billion.

Main Street Capital has found a nice sweet with the companies they are helping out with loans. The companies they are helping out are usually too big to get any loans from the SBA (Small Business Administration) and at the same time too small to get any consideration by Wall Street. Main Street Capital as their company name is pretty smart branding if you think about it.

Dividend Metrics

  • Current Dividend Yield: 7.6%
  • Dividend amount monthly: $0.205
  • Dividend amount yearly: $2.46
  • 10 year Dividend Growth rate: 5.1%
  • Years paying dividend with increases: 10

After reading through Realty Income’s 10 year dividend growth rate of 4.9% and further breakdown of the dividend amounts in 2010 vs 2015 vs 2020, I don’t think there is a need to have the same breakdown for each company. You get the general idea behind it.

I found something very interesting about their dividend policy. They have a very conservative dividend payout on a monthly basis and have a special dividend like a bonus paid out 2 times a year. This was cut for 2020 for obvious reasons. I like that they try to be safe with this so when they have a difficult year like 2020, they are not looking to cut or pause their regular monthly dividends. The $2.46 dividend is without the special dividends so once business picks up again, the total dividends will be closer to $3.00 per share a year.

3. SL Green Realty (SLG)

SL Green Realty is another REIT. It is the largest office space landlord in Manhattan and its primary focus is to acquire more properties in Manhattan and maximize value.

I am not very sure of investing in a office space focused landlord in Manhattan with all the work from home. 

SL Green Realty is a very new player in the monthly dividend game. They have had dividends since 1997 but they always paid on a quarterly basis until recently. The switch to monthly dividends occurred in March 2020. Dividends since 1997 shows a good track record but that is very deceiving. SGL fell on some hard times during the financial crash and cut their dividends to $0.1 every quarter until 2010. From 2010 onwards they have steadily raised their dividends to $0.295 every month in 2020. To make this a fair comparison, calculating the dividends on a monthly basis they have raised it from $0.03 to $0.295 over 10 years. That’s a huge 785% increase in dividends over 10 years.

Dividend Metrics

  • Current Dividend Yield: 5.8%
  • Dividend amount monthly: $0.303
  • Dividend amount yearly: $3.64
  • 10 year Dividend Growth rate: 24.4%
  • Years paying dividend with increases: 10

4. STAG Industrial (STAG)

STAG Industrial is another REIT. They focus on industrial and logistics properties – think of warehouses and distribution centers for all the online shopping you do. This is one of the companies I can think of that has done extremely well during the pandemic, especially considering that Amazon is their biggest tenant and rents about 40% of their properties.

Similar to SL Green Realty, they also paid dividends on a quarterly basis and slowly transitioned to monthly dividends in October 2013.

Dividend increase for STAG industrial is quite small and you can’t expect a big dividend hike if their history is any indication. Dividend increases have been $0.01 on a monthly basis every year since 2015. The tiny dividend hike is the disappointing part of owning STAG stock but I think the future is very bright for them since their main properties are distribution centers and warehouses. eCommerce sales are only going to go up from here so they are well positioned to take advantage of that. 

Dividend Metrics

  • Current Dividend Yield: 4.7%
  • Dividend amount monthly: $0.12
  • Dividend amount yearly: $1.45
  • 5 year Dividend Growth rate: 1.1%
  • Years paying dividend with increases: 9

Conclusion

You might get the impression that I am suggesting to invest in all 4 of them. My suggestion would be to pick one or two from this list based on how you think their future is going to look like. The performance of these stocks for the last 10 years only goes so far and nobody can predict the future.

Each of these have their own pros and cons. If I had to pick two from this list I would put Realty Income first because they have paid dividends for a really long time and then I would take STAG industrial because I believe they are in an industry that has a lot of potential growth.

Trades of the Day 01/15/2021

Twitter

Previously sold a TWTR $46 Put, $70 Call – 02/19/2021 Strangle for $312 on 12/18/2021. This has gone very poorly since with TWTR stock moving around $55 to around $45.

Initial management plan is out of the window now and it’s all about just surviving to buy it back for break even.

I have moved the call from the $70 to $55 strike and collected additional $88 in credit making the total credit collected to $400.

Breakeven for this trade if the options expired today would be $42 on the put side and $59 on the call side.

Another note – with the introduction of the beginner portfolio page, I will probably stop trades of the day post and put more energy into the beginner portfolio and topics for newbies.

Introducing Beginner Portfolio

Fishing for Money by selling options

I wrote about what are options and how to make money with options. The next logical step would be to put “how to make money with options” into action and see how it goes.

Starting amount for the portfolio is $5,000 – that should be the minimum for a beginner in my opinion.

I wanted this portfolio to be from the first of the year. since we are 2 weeks passed that, I have to take some shortcuts. I am going to cheat and use my trade from 12/30/2020 as my first trade for this portfolio.

Beginner portfolio has been added to menu bar on top. There is going to be some changes on it as I am still trying to figure out the best way to show it. Right now I am thinking 1 table for each position and 1 chart to track portfolio total.

Goals:

  1. Make 10% ($500) for the year overall
  2. Create “Monthly Income”
  3. Introduce new concepts when things go wrong
  4. Take profit at 50% 
    1. If a put option is sold for $100. Plan is to buy it back for $50 instead of waiting till the expiration date.

How to make money with options

Money in an Envelope

People usually look into options trading because they think it’s a means of getting rich quickly. Yes, there are instances where some have definitely made an enormous amount of money very quickly but the truth of the matter is very few have done that and most have lost money.

This is more of my opinion on how someone should start with options or better yet now that I know better if I could have a redo then this is how I would start with options. This is not a get rich quick method at all. This would probably fetch you between 5% – 20% a year if everything goes well.

So with my redo, I would start with something simple and straightforward. Selling a put would be the easiest to start and it’s also something that could be understood because it’s the closest thing to buying stock directly.

Before getting into the details too much, there are definitely some requirements that needs to be taken care of

  • Understand what options are
  • Money
  • Brokerage account
  • Small list of companies that you’re willing to buy
  • Understanding your risks with selling a put

The order I have listed above is not perfect, it’s what made sense to me. The important matter  is that you understand what all of it is and know the risks you are taking on.

Understanding what options are

Since this is a write-up about options and how to start with options, it’s quite important that you know what options are and I have a write-up on this that I did a while ago that you can find here. If you’re short on time the part that you want to look out for is selling put options.

Money

You already know this, you need to have some money if you want to start investing. Better question is how much money? Starting off with options $5,000 seems like a decent number for a beginner. It goes without saying the more you have, the better. More money gives you a lot more flexibility.

Brokerage account

If you are already investing then this is not really a concern. Most likely, the platform that you’re on already has options capability.

If you are looking for one, Thinkorswim by TD Ameritrade seems to be the most popular platform from what I’ve read. I have not used them so I can’t be sure. 

I started investing in 2016 on Robinhood and i think my first options trade was on Robinhood in June 2018 and I have continued using them.

If you’re signing up for a new account, you should look for commission costs and check if they have any promotion so you can get some freebies while you’re at it.

And a word of caution some of the brokerages have a tendency of saying commissions are $0 per trade but they usually have something written in smaller font that says it’s $0.65 per contract so it’s not exactly zero dollars per trade for options.

Small list of companies that you’re willing to buy

You’ll be creating a watchlist of companies that you’re interested in buying. The rule of thumb that I would use if you’re starting with $5,000 would be to find companies that are $25 per share and below. You can scale this up based on how much you’re starting off with. If you have $10,000 then $50 per share.

I’ve used finviz screener to come up with my watchlist because they have a filter for price that gives you under $10, under $20 etc. It doesn’t have an under $25 in the dropdown menu but you can fiddle around and create a watchlist with a few companies to your liking.

How did I come up with $25 per share as the threshold for a $5,000 account? it’s what I’m comfortable with. More on this below.

Technically the smaller the better so the $25 is just a guideline of what your upper limit should be.

Understanding your risks

If you read the post on what are options? and particularly the selling put options portion then you know if you’re using the $25 upper limit that I suggested earlier then that means that every time you sell a put, you’re allocating close to $2,500 as collateral (because each options contract is 100 shares).

This is also the reason why I said if your starting amount is $5,000 you want your stocks to have an upper limit of $25 because with each trade you’re probably risking half your money.


Now if you’ve done all these steps –  good. you can start and this is what you’re trying to do.

You are going to take on the role of an insurance company. This is the best comparison that I could come up with.

Using car insurance as an example – you pay your premiums and the car insurance company provides you with coverage if you get into a fender bender.

By selling a put, you are the car insurance company. You will get the premium the moment you sell the put option and you will have to cover the costs if the buyer gets into a fender bender. Fender bender in this case would be the stock you sold the put on is below the price you picked.

The steps are as follows.

Pick the Stock

Most of the hard work for picking the stock has been done already with the creation of the watchlist. From the watchlist, pick the stock that’s having the worst day.

Pick an expiration

I typically like to pick an expiration date that is 30-60 days out into the future preferably the third Friday of the month. Third Friday is the monthly expiration, those contracts are the ones that are most sought after and the ones that people are usually looking to buy or sell. If you pick an expiration date less than 30 days, most likely you won’t be able to sell the put option for a price that is worth the risk you are taking on. This could vary a lot depending on the stock.

Pick the strike price you want to sell

Time to put on the bargain hunting hat and decide what discount you would like for the stock. A 10%-15% discount seems nice to me. so if it’s a $25 stock you want to look for a strike that is $22.5 or a bit lower. You can change this to your risk profile. The closer you are to the current stock price, the more risk you’re taking on and you get paid accordingly.

Collect premium

This is the car insurance portion where you want to get the premium or monthly payment or whatever you want to call it. I look for about 1% – 2% premium for the money that I have to set aside as collateral. If I’m using the $22.5 strike, then I’m committing $2,250 towards this investment. The premium I would like to get for this risk is about $45.

Premium is just the amount I get for selling the put option. 1% – 2% is just a number that I look for. Depending on how much risk you’re willing to take you can play around with this number. Stocks that’s considered risky will have more premium than the less risky ones. 

So let me put this all together with the real stock to see what it looks like.

Step 1. Pick a stock –  I’m going to pick a Rocket Mortgage RKT for the purposes of this illustration.

Step 2. Pick an expiration –  I am looking for the next third Friday which is February 19th, 2021. This fits the guideline of at least 30 days into the future.

Step 3. Pick strike price –  Stock is trading around $20 a share right now. I want the 10%-15% discount, I am going to play it safe and select the $17 strike put for my put options which is about a 15% discount.

Step 4. Collect Premium –  $17 strike put is selling for around $55 which is a bit above 3%. Much higher than the 1% – 2% that I am usually looking for, so I am open to selling this put.

The mindset that I’m going to have here is that Rocket Mortgage is trading about $20 per share right now and I’m interested in buying the stock just not at the current price. However I’m willing to buy 100 shares of it at $17 by Feb 19th 2020. And getting $55 while waiting is not bad at all.

The best thing that can happen is Rocket Mortgage RKT stock price doesn’t go anywhere close to $17 and stays above the $17 per share price from now till February 19th 2021. If that’s to happen then I get to keep the $55 that I got initially and I move on.

The worst thing that can happen is Rocket Mortgage RKT stock price is below $17 by Feb 19th and it gets progressively worse the further away it is from the $17 strike price. For whatever reason, let’s say it’s trading at $10 by Feb 19th then I am forced to buy rocket mortgage at $17 a share but now since the stock is trading at $10 it’s only worth $1,000 for the 100 shares which is going to look like a loss of $700 but I guess I can feel okay about it because at least I have the shares now. I will probably have to hold on to them until the price recovers. This is also the reason why you want to only sell puts on stocks that you are willing to own. Do this enough number of times over and over and this is bound to happen at some point.

Let’s imagine that you are able to do this over and over for a year and are never in a position where you are forced to buy the shares, then this will make $55 about six to seven times a year which amounts to $330 on the $1700 you set aside as collateral. That’s about a shade under 20% return in a year which is really great.

One question that’s left over from all of this would be why should you have $5000 in your account if you are only planning to use only $2500 on each trade. That’s just leftover money to use whenever a great opportunity comes along. You never know when a great opportunity will come along and whenever it does you want to have the funds to do something about it. This cash reserve is also called dry powder. 

Conclusion

For folks starting with options, this is going to be a bit cumbersome and it will take some time to get used to these steps. After a few iterations it will come more naturally.

This step by step cheat sheet of sorts would come in handy for people who are looking to buy specific stocks.  

A few things to remember are pick companies you want to own, define the risk you are comfortable with and only sell puts for prices that you think are worth the risk you are taking. 

Bonus tip:

Once you sell and you want to sound like a know-it-all then here two things you could say. I am going to use the Rocket Mortgage RKT example again.

  1. You could say you are short the $17 strike put – It means you sold the $17 strike put.
  2. You could say you are long RKT – it means you want RKT to go up in price.

Trades of the day 12/29/2020

Rolling the Dice with DKNG

Old: 1 AAPL $112.50 Put, $145 Call – 01/15/2021 Strangle sold on December 18th 2020 didn’t work out as hoped. Closed it for $145. Not a win, not a loss. Closing and moving on.

New: Sold 1 DKNG $42 Put 01/22/2021 for $105. Collateral is around $520 including credit.

  • Management Plan – Close out for 50% profit.

What are options?

Raining Money

Options are financial contracts that give the buyer the right and not the obligation to buy or sell a stock at a specific price by a certain date.

The seller has the obligation to buy or sell the stock at that specific price if the buyer wants to at that specific price.

This all sounds very formal and I am sure that definition is a modified version of something I read in the past. 

This is a pretty straightforward concept or at least it’s supposed to be straight forward but anytime I’ve read about it, it’s just complicated. Options are flexible and people use it for different purposes and I think trying to explain all of that makes it complex for anyone let alone a beginner. The flexibility that comes with options makes it a very vast topic and jumping into them with a lot of money in the beginning can quickly spiral out of control leading you to lose all of your money. Here, I will try to explain the very basics (just scratching the surface) of options but before we get into them, there are a few terms that you have to know.

  1. Strike price

It’s a contract so two people have to agree on what price the shares are going to be bought or sold. That’s the strike price.

  1. Expiration

This contract is only valid for a certain amount of time. That’s the expiration date. Another way to think about it is like your car insurance where you pay your premium for 6 months and you get coverage for those six months. Once those six months are over and if you don’t pay again then you don’t have insurance. Your coverage is over. your contract has expired.

Popular stocks that trade very often and are household names have contracts that expire every Friday for the most part and the rest of them have one expiration each month which is on the third Friday of every month.

  1. Premium

Using the car insurance example, you pay a premium to have the insurance. Similar to that, a buyer has to pay a premium to have the opportunity to buy or sell the stock at the strike price. This applies to anyone buying an option.

  1. Collateral

if you get into a car accident your insurance company covers the cost because of the insurance contract you have. The money that is set aside by insurance companies to pay for those damages is the collateral. Depending on the kind of option, the collateral can be money or stock. This applies to anyone selling an option. It is also called buying power reduction if you are using a margin account.

  1. Option size

This is not a definition per se. This is more of a need to know. Each option contact is for 100 shares. 

There are two types of options

  1. Call
  2. Put

There are two parties involved

  1. Buyer
  2. Seller

Combining all of these different variables seems very daunting but those give you the flexibility of making a directional bet easily. 

As a beginner to options this is how I look at it. The risk is different depending on what combination you go with.

If you think a stock will go up then you can either buy a call or sell a put. The amount of money you can make will be vastly different and the way you would set up the options contract would be different. Buying a call would cost you very little upfront and the amount you can make from is astronomical if the stock skyrockets. Selling a put would require you to keep a significant chunk of money as collateral and the maximum profit would be whatever you collected initially as premium when you sold the put option.

So how does this work and what would it look like

Buying call options

XYZ company is trading at $50 a share right now and you think the stock is going to move up to $70 a share in two weeks. 

You might consider buying the $60 strike call option that expires a month away for $1.00. This will cost you $100 because each option contract is for 100 shares. This is the premium.

If your assumption comes true then you stand to make $9 per share ($900 because a contract is 100 shares) 

The calculation works out to be $70 per share which is the stock price at expiration minus $60 per share which is your strike price and then minus the $1 per share you paid in premium.

This would be a 900% return because you made $900 using $100. The same move in the stock will get you a return of 40% where you would make $2,000 in profits on the initial $5,000 spent to buy the stock.

$70 – $60 – $1 = $9 

Stock price at expiration – Strike price – Premium Paid = Profit

This is great when everything works out the way you want but what if the stock price stays at 50 and does not move at all then the call would expire worthless and you would lose the $100 you paid initially as premium.

When and why would you do this?

  • Amplified returns.
  • You are convinced the stock will move up dramatically in a certain time frame. Especially handy for small biotech companies that sees a big stock price jump after getting FDA approval.
  • You are willing to lose the premium if the stock move you are hoping for doesn’t pan out.
  • More Misses than hits.
  • YOLO move – you only live once or you really lose once depending on how you look at it.

Selling put options

All the assumptions for XYZ company stays the same, XYZ company is trading at $50 a share and you think it will go up to $70 in two weeks

You might consider selling the $30 Strike put option for a month out for $1.00 ($100 since the contract represents 100 shares). This will cost you $3000 in collateral.

If they stock moves up to $70 a share in a month then the contract expires worthless and you will keep the $100 in premium you collected. Well as long as the stock price stays above the $30 strike price at expiration, you will keep the $100 collected initially.

If the stock is below the $30 then you will have to buy the stock at $30 a share since that is the contract you agreed to. This is where the $3000 collateral comes into play. You have already set this money aside when you started this trade.

The calculation works out differently from buying a call, you already know the maximum you can make is $100 as long as the stock price is above $30 a share at expiration.

Your return would be $100 on $3,000 you put down as collateral. This would be 3.33% in one month

When and why would you do this?

  • Consistent returns.
  • It’s a stock you like but you want to buy it at a lower price.
  • You think the stock will move but you are not fully convinced of it.
  • You want to get paid while waiting for the stock to come to a lower price.
  • More hits than misses.
  • Generate an income-based investing or trading.

Now moving to the other side, the scenarios are going to sound very repetitive since it’s just the other side of the same coin.

If you think a stock will go down then you can either buy a put or sell a call. Everything in this portion works in reverse of the items mentioned above. Buying a put will cost you very little upfront and the amount you can make from it is significant if the stock tanks. A key difference here compared to buying a call is that there is a limit to how much you can make because the worst that can happen to a stock is for it to go to $0. Similarly to selling a put, selling a call would require you to keep a significant chunk of money as collateral or 100 shares of the stock and the maximum profit would be whatever you collected initially as premium when you sold the call option.

Buying put options

Buying a put resembles the car insurance analogy I gave earlier except you are hoping for an accident to happen. Pay the premium and get a big payout if things go horribly wrong with the stock. But a less cynical way to look at it is buying a put option to protect stock you already own and in this way the put will behave exactly as having car insurance where you pay your premium just in case something bad happens.

Using the same XYZ company as the example, XYZ company is trading at $50 a share right now and you think it’s going to come down to $30 in two weeks. You can buy a put at a strike price of $40 spending $1 in premium which would be $100 because each contract is one under chairs.

Similar to buying a call, if everything works out you would net $900 profit after spending $100 in premium.

The calculation works out to be $40 per share which is the strike price minus $30 per share which is your stock price at expiration and then minus the $1 per share you paid in premium.

This would be a 900% return because you made $900 using $100.

$40 – $30 – $1 = $9 

Strike price – Stock price at expiration – Premium Paid = Profit

When and why would you do this?

  • Amplified returns.
  • You are convinced the stock will move down dramatically in a certain time frame.
  • A cheap way to protect stock you already own.
  • You are willing to lose the premium if the stock move you are hoping for doesn’t pan out.
  • More Misses than hits.

Selling call options

We are back to XYZ company and it’s trading at $50 a share and you think it will go down to $30 in two weeks.

You might consider selling the $70 Strike call option for a month out for $1.00 ($100 since the contract represents 100 shares). This collateral is a bit iffy, you can put 100 shares as collateral or it would be an amount that is calculated by your broker if you have a margin account.

If the stock moves down to $30 a share or stays below the $70 strike price in a month then the contract expires worthless and you will keep the $100 in premium you collected.

If it doesn’t work out then you sell the shares at the agreed strike price.

When and why would you do this?

  • Consistent returns.
  • Make money on the stocks you already own.

Conclusion

Options are risky but the first step is to understand what options are so you can understand the risks associated with them. Buying options is the easy part where you could potentially make a lot of money but the trade off is you will have more losers than winners. Selling options gives you a cap on maximum returns and statistically have more winners than losers.

Trades of the Day 12/18/2020

Twitter
  1. Sold 1 TWTR $46 Put, $70 Call  – 02/19/2021 Strangle for $312. Collateral for the trade is $877 including the credit collected.
  • Management plan – To close out at 50% if it reaches that before Twitter earnings on 02/09/2021. If it doesn’t reach 50% before earnings, then take it off before earnings to avoid earnings announcement.
  1. Sold 1 AAPL $112.50 Put, $145 Call – 01/15/2021 Strangle for $145. Collateral $1430 including credit. 
  • Management plan – close out next week hopefully for a small profit.
  1. Sold 1 EWZ $33 Put, $43 Call – 02/19/2021 Strangle for $130. Collateral $509.
  • Management plan – to close out for 50% profit. Don’t have to worry about earnings since it’s an ETF.