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Options Strategies for Monthly Income Explained with Example

Options Strategies for Monthly Income Explained with Example

The future & option market contracts mostly have a life cycle of one month, two months or three months as there are expiry dates of these contracts. You have a limited time period to make your option trade position profitable or exit timely to avoid losses.

Options trading is highly volatile trading as there are equal chances of earning handsome profits or losing your money. There is no fixed source of income as the market can move in any direction or be unpredictable till the date of option expiry.

But do you know, if you trade with a certain strategy in the option market you can earn monthly income from option trading? To trade in such strategies you have to enter multiple positions, which means buying and selling different strike prices of the same strike price called hedging your position and getting some of the return on or before the expiry day.

What is an Option Trading for Monthly Income?

Options trading for monthly income are the strategies that have the potential to generate income consistently every month at the end of the option contract expiry. However, more precisely, the option-based monthly income strategy involves the selling of call putor both options and taking advantage of premiums as a regular source of income.

Selling the option strategies provides an opportunity to earn income monthly from the premiums received as the upfront money from the option buyer with limited profit and unlimited risk. To trade with option strategy for monthly income you can use various option strategies like covered calls, bull or bear credit spreads or cash-secured puts as per the different market conditions. So, let’s find out what the best options and strategies can be used for monthly income.

Also Read: How to Use Traderadar for Option Strategies as Market Conditions

10 Options Trading Strategies for Monthly Income

  1. Covered Calls

Selling covered calls for monthly income is one of the most common option strategies that you can also use for the monthly income. In this option strategy you have to sell the call options of the shares that you already bought. This is called covered calls, as the option seller already has the same quantity of shares, and if the option call is exercised it can be covered by the selling of the shares.

In this option strategy option seller will earn income immediately at the time of selling the calls. The maximum profit the option seller can achieve is when the price of the underlying security does not move close to the strike price by the date of expiry and the call settles worthless making the premium as an income for the call seller.

In this option strategy, the maximum loss could arise when the price goes beyond the strike price obligating the option writer to sell the shares at the lower strike price. However, the loss is limited that is the difference between the strike price with market price and brokerage or transaction fees.

To make it understand better, let’s take an example, if you have 200 shares of a company that are trading at Rs 100. As a covered call,you have to sell one call of the near month of the strike price of Rs 110 at the premium of Rs 5. Here your maximum profit will be Rs 1000 you have received as a premium. In this trade position, the breakeven point will be Rs 105 (strike + premium).

The maximum loss would be Rs 110 only when underlying security rises above that providing the income potential with the limited risk. In this covered call strategy will enjoy the benefit of generating income from the stock they already own. However, if the price of the underlying security moves above the strike price, the gain is not possible.

  1. Put Credit Spread

This option called strategy is also called the bear-out spread that can give you returns when the price of underlying security either rises or stays around the same levels. In Put Credit Spread, you have to sell a put option at the one strike price, and at the same time also buy a put at the lower strike price of the same underlying security.

This put credit trade position is spread is option strategy having the limited profits that can be earned only when either price of the underlying security remains the same or stabilizes. The maximum profit in this option call strategy is the total credit received from the spread you created. While the maximum loss is equal to the difference between the long and short put strike minus the initial net credit.

Also Read: What is Short Selling & How Does it Work: Is it Good or Bad

  1. Protective Put

This call strategy is also known as married put, similar to the covered call but a little bit different. In this option strategy, you own shares of the underlying security and put an option to sell the same. To make it understand better, let's take an example.

To trade with this option strategy suppose you bought 1000 shares of an ABC company at Rs 200 price with a total investment of Rs 200000. Simultaneously, also purchase the put option to sell the same if the stock price goes down atRs 170 in the next months. And to buy this you paid Rs 10 premium, so your total premium goes to Rs 10000.

Now if the stock price of ABC Company moved up to Rs 250 per share by the end of the expiry of the month, you made Rs 450 per share on account of option premium. While on the other hand if a price drops to Rs 150 a share you can exercise your option to sell at Rs 170 a share. Here instead of losing Rs 5000, you will lose only Rs 3000 plus the premium you paid.

  1. Protective Collar

This strategy works, when you own a stock and sell a covered call, and also buy a protective put. Here protective collar works when there is a neutral position with the purpose of hedging the stock from falling. The risk in this option strategy is very low.

In this protective collar strategy, the premium paid to buy the put option is offset by selling the call option. However, this option strategy will generate income when you sell the call option at a marginally higher than what you paid for the put option. If underlying security does not move and remains stable, the strike price is not achieved, hence you gain some profits despite no movement.

  1. Straddle Option

Straddle is another popular option strategy that can be used for income generation. While entering into this option strategy you expect the underlying security will move but not sure in which direction. Hence, you buy an at-the-money (ATM)put and a call option of the same underlying security that both have the same strike price and expiration date.

If you hold both this position a call and put option simultaneously till the date of expiry it can give unexpected profits as there is no limit to how high or low it can move till the date of expiry. While the loss could be the premium price you paid to enter into this trade.

The straddle option strategy works when there is significant movement in the underlying security, as the high volatility will increase the value of both options. And you can make profits when it moves sharply upside or downside.

Also Read: What is Profit Booking in Stock Market: Rules & Best Strategy

Let's take an example, under the straddle option strategy, you have to buy at-the-money of Rs 500 contract at Rs 50 of an underlying security. Here your profit will start above Rs 550 or below Rs 450. At the time of expiration, the price of Rs 500.50 or Rs 499.50 will make your strategy profitable due to offsetting the time decay.

  1. Strangle Option

This is a non-directional option strategy that can give profit when the price of the underlying security is highly affected due to high implied volatility. Unlike straddle, in strangle, you have to use options with different strike prices instead of choosing the same strike.

Also Read: How to Trade in High Volatile Market: Best Trading Strategies

In this option strategy, you need less cash, as you have to buy an out-of-the-money (OTM) call and put an option on the same underlying security. Choosing the OTM options reduces the net premium and the potential of profits in this strategy becomes unlimited as there is no limit due to high volatility the price of the underlying security can move.

  1. Iron Condor

It is one of the best option strategies for monthly income that can be established with a combination of four contracts. This option strategy can be profitable when you expect volatility would be low.

In the iron condor option strategy, you have to buy a call and put option and simultaneously sell a call and put option. Let's take an example, the stock price of a company is trading at Rs 500, here you buy a call option of Rs 600 and a put option of Rs 400 both have the same date expiry.

Now you also need to sell a call option of Rs 550 and put an option of Rs 450 of the same date expiry. In this option strategy you can earn from the premiums, but it costs you more to buy an option that has a higher chance of hitting the strike price. As your long position is too far away from the current price of the underlying security, you are paying a low premium for that.

You can earn the profits from the premium that you have earned by selling the call and put. If there is low volatility in the market or in the underlying security, and the strike price is not achieved, the contract will expire worthless and you earn income from the premiums you have received.

  1. Iron Butterfly

Iron butterfly is another useful option strategy that works well when implied volatility remains high but decreases through the date of expiration. In this call strategy, you have to hold both a bull call spread and a bear put spread at the same time of the same underlying security.

In this option strategy, you sell an at-the-money (ATM) call and buy an out-of-the-money (OTM) call with a higher strike price. At the same time, sell an ATM and buy OTM with the lower strike price. Here the maximum profit would be within OTM calls and puts wings within expiry.

This would be possible when implied volatility remains high or cools down as per the expectation of the value of the premium. On the other hand, the maximum loss would be if underlying security settles below the lower put range or above the higher call wing due to sharp movement that would be unexpected.

The Iron Butterfly option butterfly strategy does not work if the volatility increases or the market moves in a single direction beyond the wings. The breakeven point is very thin, but this strategy can generate income only when executed with extraordinary skills and favourable market conditions.

  1. Call Credit Spread

This strategy is also known as a bear call spread, which has limited risk with the profitability potential from the underlying security price either remaining the same or declining. Under this strategy you have to sell a call at on strike price at the same time also buy a call at a higher strike price.

When the underlying security remains stable or declines till the expiry it will give you the profit with the limited risk. To establish this option strategy, sell an at-the-money (ATM) or out-of-the-money (OTM) call option and use the premium to buy the OTM call with a higher strike price.

In this option strategy, the maximum profit is limited to the net premium collected while entering into this trade position. While on the other hand, the maximum loss would be equal to the difference between the call strikes minus the net premium collected.

This call will give profit due to time decay if the stock remains below the sold call strike price on the date of expiry. The premium you received surpasses the cost of the call you bought if it expires worthless or you can say at zero premium.

  1. Cash Secured Puts

However, it is a very conservative option strategy in which you have to sell put option of an underlying security that are willing to own from the income generation perspective. In this option strategy, you have to keep sufficient cash to buy the underlying security at the strike price of the put, if you are bullish on any underlying security, you can generate income by selling the put options.

Here you have to keep one thing in mind, that you should have enough cash set aside in your trading account must be equal to put strike price multiplied by 100 shares per contract.

When you sell the put of the strike price below the current market price of a stock with enough cash it will allow you to get the income through the premium you collected. However, the highest profit can be earned when the security trades above the put strike price on the expiry day with zero.

The downside the risk of loss in secured put option strategy could arise if the stock price goes below the put strike before the expiry day and the highest loss is limited to buying the shares for the strike price. Hence, the cash-secured put option strategy requires funds for stock bought at the time of collecting the option premiums.

Summing-up

As of now, you would be aware that an option strategy for monthly income involves mainly selling the option contracts that settle at zero prices or become worthless at the time of expiry and become the regular source of income if executed precisely and works as per the expectations.

Though, there are combinations of buying and selling of both call and put options, ultimately, the net income comes from the difference of the entire net earned premium.

Also Read: Why Option Selling is Better than Option Buying: Explained

Apart from that you can also choose the bullish option strategy, bearish option strategy and option strategy for the sideway market as per the different market conditions. The most important thing to earn from options strategies is to trade with the best online trading platform that offers the lowest brokerage demat and trading account to minimize your cost of trading.

Also Read: What are the Benefits of Demat Account: Advantages & Why you need it

You can choose Moneysukh for option trading or invest in equities or trade in commodities and the forex market. It is one of the best discount brokers in India, providing the one-stop investment solution to invest in various market segments including equity, commodity, derivatives and IPOs with the advantages of an online trading platform available at the lowest pricing.

Also Read: Questions You Need to Ask Before Choosing a Discount Broker in India

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