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How to Collect Extra Monthly Income With One Simple Trade

Andy Crowder Chief Options Strategist To succeed long-term, not only do you need a sound strategy, but you must also be able to follow the strategy throughout the market’s emotional roller-coaster ride. Gut reactions, prevailing markets beliefs, and conflicting views of market pundits are just some of the elements that put an emotional spin on the decision-making process.

- John Balkowski in an article written for The American Association of Individual Investors

You would not buy a car that didn’t go in reverse, right? Why should investing be any different?

Having strategies and investment vehicles that can profit when the market retreats is just as important as having a car that goes backwards.

We’ve seen this fact play out in the markets lately: long-only equity portfolios will not perform well during bearish market cycles.

Therefore, you have to make certain that your portfolio has access to investments that go forwards AND backwards. You need to employ strategies that can profit during up markets, down markets and, perhaps most importantly, in sideways markets.

That’s why I use options strategies that have the potential to make money in any type of market environment.

If used properly, options are a powerful investing tool for individual investors.

But options weren’t always as useful as they are today. Innovations in technology have allowed the retail trader to trade on an equal playing field with the professional options trader. Individual investors now have the opportunity to participate in one of the most important developments in the field of investments of the last 25 years.

And that’s why we were able to develop Options Advantage -- a new product that brings the world of practical and profitable options trading to the individual investor.

My goal in writing this special report is to provide an easy-to-follow guide to my two favorite options strategies. These are the two strategies I use in the building the Options Advantage portfolio.

I’ll provide a map that will guide you through the construction of these options strategies. I’ll discuss the risk/reward profiles inherent in each strategy. And I’ll show how these strategies can complement your investment objectives.

But first … whether you’re an advanced options trader or you’ve never traded options before in your life, I want you to take a deep breath.

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Keep your eyes open. Don’t feel like you’re rushed to do anything. You are about to take an important step into a world of options that few people enter.

When you first started investing, you probably were somewhat overwhelmed. You felt a little unhinged, perhaps a little nervous. So I want to reassure you that there is no rush. Nothing in this report is too difficult, complicated or unapproachable.

When the time comes, I will send you an actionable trade to execute. But before that day, I want you to read and re-read this report until you feel somewhat comfortable with the ideas presented. Be patient. The day will come when everything you read below will become second nature. And you will trade options with the same confidence and ease as you do putting your car into reverse.

Introduction

Utilizing a variety of options strategies is much like investing in a diverse array of stocks. As we all know, diversification is the key to long-term success. It’s not only mathematically logical, but also a financially sound practice. Why fight the likes of Nobel laureates Markowitz, Miller and Sharpe - the fathers of portfolio diversification?

My strategies can easily be integrated into your current investment portfolio even if it’s an individual retirement account. I hope that you NEVER “put all your eggs in one basket.” It’s too risky. If you drop the basket, you can lose everything. Smart investors would never employ this type of reckless investing, as the risk far outweighs the reward.

I seek to achieve superior risk-adjusted returns through short-term trading, switching between cash and options on highly liquid exchange-traded funds (ETFs) such as SPY, DIA, QQQQ, IWM, etc. Each strategy operates in conjunction with buy or sell signals generated by my own proprietary models.

It is my hope that this report and subsequent use of my Options Advantage service will introduce you to the most important aspects of stock options. The goal is for you to start earning a steady income and boost your portfolio returns using options-based investing every month, regardless of market direction.

Moreover, unlike most options-based newsletter services, Ian Wyatt has set up a real $25,000 portfolio for you to watch and mirror if you wish. Whenever I make a trade, I will email it immediately so you can do the same in your own account.

But you won’t just get my trades. You’ll also get an idea of the appropriate position sizing. I’ll never risk the entire $25,000 on one trade. So not only will you have the rationale behind each and every trade, but you will learn the most important aspect of options trading - portfolio management.

Through the various risk-management techniques I use - including position sizing, time management, strategy diversification, etc. - you will quickly learn the reason why capital preservation is the key to any trading strategy, especially options-based strategies.

Another benefit of my members-only trading service is that you can sit back and let me worry about the details. In other words, you don’t need to be an options expert to use this service effectively.

And as always, I am here to answer your email inquiries to help with any questions that you may have regarding the wonderful world of options.

So let’s get started.

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Why Options?

Trading options is not like trading stocks. Most investors make the mistake of bringing their experiences and ideas about stock investing into the field of options. They view options as a leverage investment on a given stock or ETF and nothing else. Whatever direction the market moves decides the fate of your trade. This might be the case when trading stocks, but it doesn’t have to be so with options.

Options traders do not view the markets as binary (long or short). Rather, an options trader makes an assumption based on his view of the market. He determines how bullish or bearish he is and applies the options strategy that best serves his assumption. Once the options trader chooses an appropriate options strategy, he has the ability to choose a specific probability of success and the risk tolerance of his choice for each and every trade.

You simply can’t craft such specific and effective investment strategies in stock trading.

Stock traders do not have the ability to be partially correct and still make exceptional returns. But that’s the whole point of using options effectively: putting yourself in the position to make money, even if you’re only partially correct in your assumptions.

Investing in options can allow you to make money on the randomness of the market – bullish, bearish or neutral, it doesn’t matter – as long as you give yourself some cushion.

I realize this concept might be foreign to some, but I will show you how the concept is applied in my two options strategies.

Of course, there are risks and tradeoffs associated with options. But it’s a mistake to see any asset class as being non-risky.

You can’t avoid risk in the financial world. Even holding cash has risk.

I will go over the risks associated with each type of trade I use in Options Advantage because it is just as important to understand your risk as it is your reward.

I am confident that once you learn how to properly use options, you will immediately find them to be the most powerful tool in the investment arena. Not only that, I feel they are a necessity to outperforming the market.

The Foundation of Options – Puts and Calls

The textbook definition of an option is as follows:

The right, but not the obligation, to buy or sell a specified asset at a predetermined price over a predetermined time.

While this definition is technically correct, it makes my eyes glaze over every time I read it.

My goal is to bring options to the forefront, to dispel the mystery of how they are used and to show you how to use options in an effective and responsible manner. Definitions, like the standard one mentioned above, only make options more difficult for the average investor.

Simply stated, options can be bought or sold. An investor who buys an option is long the option. A person who sells an option is short the option. Simple, right?

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Buy = Long; Sell = Short. When you “buy to open” an option, thereby paying a debit, you are said to be long that option. When you “sell to open” an option, thereby collecting a credit, you are said to be short that option.

There are only two types of options: calls and puts.

Every position that is built using options is composed of either all calls, all puts, or a combination of the two. One thing that smart option traders know is that you can sell options as easily as buy them. That is one of the main themes running throughout the Options Advantage service and it is clearly seen in the Options Advantage portfolio. By knowing how to incorporate both the buying and selling of options, you will learn the key strategies used by most professional options traders.

So what exactly are call and put options?

Both puts and calls can be either bought or sold, just like stocks. Most beginners start by just buying calls and puts. One of the strategies I use in the Options Advantage portfolio - the High-Probability strategy - only buys calls and puts. I will go over the details of the strategy in our special report, “Using Options on ETFs for Wealth Protection and Portfolio Growth.” But first I want to make sure we have a sound understanding of what it means and takes to buy calls and puts.

The buyer of a call option has the expectation that the underlying security is going to move up. “Underlying security” refers to the stock, ETF or commodity the option is based on. In most Options Advantage trades, the underlying is an ETF.

A call buyer has the right to control a bullish directional position of 100 shares of stock per options contract for a specified time (until options expiration) at a certain strike price.

The call buyer essentially pays a fee to the option seller for this right, which is called the “premium.”

Investors who sell calls or puts (like we do in the Options advantage service) use option premiums as a source of current income in line with a broader investment strategy to hedge all or a portion of a portfolio. Option prices quoted on an exchange such as the Chicago Board Options Exchange (CBOE) are considered premiums as a rule because the options themselves have no underlying value. The components of an option premium include its intrinsic value, its time value and the implied volatility of the underlying asset. As the option nears its expiration date, the time value will edge closer and closer to $0, while the intrinsic value will closely represent the difference between the underlying security's price and the strike price of the contract.

Again, intrinsic value and time value are two of the primary determinants of an option's price. Intrinsic value can be defined as the amount by which the strike price of an option is in-the-money. It is actually the portion of an option's price that is not lost due to the passage of time. The following equations will allow you to calculate the intrinsic value of call and put options:

Call Options: Intrinsic value = Underlying Stock's Current Price - Call Strike Price Time Value = Call Premium - Intrinsic Value

Put Options: Intrinsic value = Put Strike Price - Underlying Stock's Current Price Time Value = Put Premium - Intrinsic Value

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At-the-money and out-of-the-money options don't have an intrinsic component because they do not have any real value. You are simply buying time value which decreases as an option approaches expiration. The intrinsic value of an option is not dependent on the time left until expiration. It is simply an option's minimum value; it tells you the minimum amount an option is worth. Time value is the amount by which the price of an option exceeds its intrinsic value. It is also referred to as extrinsic value and decays over time. In other words, the time value of an option is directly related to how much time an option has until expiration. The more time an option has until expiration, the greater the option's chance of ending up in-the-money. Time value has a snowball effect. If you have ever bought options, you may have noticed that at a certain point close to expiration, the price seems to stop moving anywhere. That's because the time component of price decays exponentially; the closer you get to expiration the more a move in the security is needed to impact price. On expiration day, all an option is worth is its intrinsic value. It's either in-the-money, or it isn't.

Now that you know what calls and puts are, let’s move to something a little more complex, but certainly not difficult.

The sellers of calls and puts have different views and obligations than the buyers of calls and puts. Options traders sell options to bring in income. This is included in the special report, “Using Options ETFs for Wealth Protection and Portfolio Growth.”

The seller of a call has a neutral to bearish view of the underlying security. The seller does not want the underlying security price to advance above the strike price. Why? If it does, the call buyer will exercise their right to buy the shares at the strike price. The seller would have to go into the market, buy the underlying at the higher market price and then sell it to the call buyer at the lower strike price. In short, the seller will lose money if the difference between the strike price and market price is greater than the premium collected up front.

The seller of a put option has a neutral to bullish view of the underlying security. The seller does not want the underlying security price to decline below the strike price. Why? If it does, the put buyer will exercise their right to buy the shares at the strike price. The seller would have to go into the market, buy the underlying at the lower market price and then sell it to the put buyer at the lower strike price. In short, the seller will lose money if the difference between the strike price and market price is greater than the premium collected up front.

I do not sell calls or puts by themselves…otherwise known as selling naked calls or naked puts.

Rather, I sell what is called vertical call spreads and vertical put spreads for reasons I will discuss in my Options Advantage strategy report, My Options Trading Toolbox – Revealed. So let’s review.

Buy calls (debit) = long calls = bullish on the market Buy puts (debit) = long puts = bearish on market Sell calls (credit) = short calls = slightly bearish to neutral view Sell puts (credit) = short puts = slightly bullish to neutral view

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Debunking Common Myths about Options

The most common myth about options is that they’re risky. As I already explained, every investment is risky.

Your potential for loss in options doesn’t have to be any greater than your potential for loss in stocks or bonds or commodities.

The other big myth is that some options traders are able to vastly multiply their wealth in short order.

But the same rules apply here as well. If you make big bets on high risk-reward trades … well yes, you can make lots of money very quickly. But you can lose a lot very quickly as well. The same can be said of penny stocks or the roulette wheel.

Options are vastly misunderstood and typically used improperly by inexperienced traders. Oftentimes, new options traders attempt to make inherently greedy decisions by choosing “pie in the sky” strategies rather than a methodical, steadfast approach. They ignore the fact that they are able to greatly increase their chances of success by using of a highly leveraged strategy. They want to strike gold and become rich overnight … which is basically the same as buying a lottery ticket.

If you want lottery-like results, go play the lottery.

My approach is much different. I allow the statistics to work for me, not against me. I aim to hit singles and doubles with a high rate of success. Of course, from time to time a home run will occur, but this type of trade should be deemed an anomaly.

Simply stated, I have the ability to create my own odds of winning on each and every trade.

I hope you are not overwhelmed so far. I want to keep it as simple as possible because it is important to me that you understand exactly how I trade options.

My hope is that you are able to grasp the idea of buying and selling options. Once you understand the basic fundamentals surrounding options, you will be well on your way to learning the strategies I use for the Options Advantage.

What You Need to Know Before Using Options

The easiest way to search for optionable ETFs (i.e., ETFs that have options) is to screen for them using a stock screener such as FinViz.com.

This screener is extremely easy to use and only requires three simple steps.

1. Click on the 'All' tab

2. Set Average Volume to "Over $1M"

3. Set Option/Short to "Optionable"

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(Click the image to enlarge)

This first screen searches for all ETFs that not only have options (many ETFs are not optionable) but have sufficient trading volume so that their price action is not based on a few large trades. I suggest saving this screen for future reference so you can go back and check your list to see if your next ETF of choice is optionable. Thank me later, as this is a true time saver.

The most important search criteria for finding what I call “tradeable” options on ETFs is VOLUME. The reason I chose to search for ETFs with an average daily volume of more than one million shares is because I want liquid options. And ETFs that trade in high volume give me a better chance of finding these critical liquid options.

You see, the more liquid the option, the tighter the bid/ask spread. This is extremely important because the bid/ask spread impacts the cost of using options. Wide bid/ask spreads eat into the potential profitability of your investment, and contribute to what is known as “slippage.”

A real-world example of how volume affects the bid/ask spread should help to clarify.

Let's use PowerShares Nasdaq 100 (NYSE: QQQ) and Market Vectors Agribusiness (NYSE: MOO) for our exampIe. I chose these two ETFs because they both had roughly the same share price (around $50) when I did this analysis and I want to compare ETFs with similar properties … other than volume. The impact of volume will be blatantly obvious on the bid/ask spread.

For example if you look at the January 50 calls for both stocks you will see the following bid/ask spread:

Avg. Vol.

Bid Price

Ask Price

Market Vectors Agribusiness (NYSE: MOO)

1.8 M $2.10 $2.50

PowerShares Nasdaq 100 (NYSE: QQQ)

76 M $4.83 $4.85

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Notice the difference?

The bid/ask spread is $.02 on QQQ compared to an enormous $0.40 on MOO.

The significance of a tight bid/ask spread because you buy at $2.50 and sell at $2.10. You’re already down $0.40 at the onset of the trade or 16%. It’s like driving a new car off the lot. With QQQ, you are only down less than half a percent. Because again, you buy at the ask and sell at the call.

is the reason why a tight bid/ask spread is so critical when using options as part of your investment strategy. You can rarely buy an options contract at anything other than the ask price, and you can rarely sell at anything other than the bid, especially if the options are illiquid. It is you versus the market maker and believe me, you will never win that battle. With the wide bid/ask spread seen with MOO above, you’re already down 16% just by making the trade (the option you bought for $2.50 can be sold for $2.10). Nobody wants to make up that kind of loss just to break even.

To sum up, dealing with the bid/ask spread is an inevitable part of options trading. Focus on more liquid and actively traded options that have smaller bid/ask spreads, rather than stocks with little to no volume and wide spreads. This is an important lesson to learn when using options as part of our investment strategies. You will save yourself many headaches and most importantly, hard-earned money.

The Tool - RSI

One of the biggest mistakes I see new traders make is that they keep digging into the toolbox for a new technical indicator every time they see something they like.

I can’t tell you how many traders I know that want to follow bull flags, bear flags, candlestick patterns, channel retracements, Fibonacci retracements … the list goes on and on. They’ll try to impress you with their long list of indicators. But in reality most are horrible traders over the long term because they overwhelm themselves by constantly switching to the latest and greatest indicator that happens to fit their current market perspective.

Or they’ll use several indicators at once. And that creates a mess because there will inevitably be a conflict between two or more signals. It’s called “analysis paralysis.”

For me as an options trader, I’m looking to make steady, reliable gains without too much of a holding period. I keep it super-simple when I trade. I pick one tool and I use it for its specifically intended purpose.

So in order to make options trades I use a tool that helps me do a few things:

1) It alerts me that a profitable trade may be on the horizon – which gives me time to prepare.

2) It tells me when I should think about getting out of a trade.

3) It lets me adjust my time horizon to craft a trade that fits my needs.

As I said before, I keep it very simple. I use a few basic versions of ONE simple tool model to take advantage of sentiment and technical extremes on highly liquid ETFs.

So with that being said, the most powerful technical indicator that I use in my proprietary model is the Relative Strength Index (RSI).

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Developed by J. Welles Wilder, Jr., RSI is an overbought/oversold oscillator that compares an ETF’s or other entity’s performance to itself over a period of time. It should not be confused with the term “relative strength,” which compares one entity’s performance to another.

Basically, RSI allows me to gauge the probability of a short- to intermediate-term reversal. It does not tell me the exact entry or exit point, but it helps me to be aware that a reversal is on the horizon.

Knowing that a short-term top or bottom is near increases the probability of a potential trade. Similarly, knowing that a reversal is on the horizon allows me to lock in profits on a trade.

For I am a contrarian at heart and I prefer to fade an index - whether overbought or oversold - when the underlying index reaches a “very overbought/very oversold” state. Fading just means to place a short-term trade in the opposite direction of the current short-term trend.

Of course, other factors must come into play before I decide to place a trade. But in most cases, I do know that a short-term reversal is imminent when an index reaches an extreme state.

Here’s how I interpret RSI readings for what I call my “High-Probability Trades”:

Very overbought – 85 and above Overbought - 75 to 85 Neutral - 30 to 75 Oversold - 20 to 30 Very oversold – 20 and below

Since I’m looking for extreme conditions, I almost always only focus on very overbought and very oversold conditions. When an asset hits more neutral levels, that’s an indication to close the trade out.

I use three different RSI time frames. The shorter the duration, the more I want to see an extreme reading. These time frames are two, three, and five days or RSI (2), RSI (3), and RSI (5).

So now that you have the basics of the strategy, let me go over an example.

The following example is a trade I recently closed in my Options Advantage portfolio:

Background: The iShares FTSE China 25 Index (FXI) surged roughly 18.7% over just six trading days starting October 20th. The surge lasted until October 27th, when FXI had pushed into a short-term “very overbought” extreme.

You can see the “very overbought” state across every RSI timeframe in the chart below. When such a situation arises – and it happens rarely - it’s a high-probability trade that should be taken advantage of.

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Again, if you look at the RSI (2), (3) and (5) readings below the chart, you will easily see that a short-term overbought extreme had been hit. At that time, I want to make sure my other proprietary indicators line up. If so, I will fade the move.

Remember that fading means placing a trade that opposes the current trend. In this case the move was higher; therefore I bought puts. (Remember that you make money buying puts if the underlying asset goes down). If the market was in a short-term oversold extreme for FXI, I would have purchased calls.

The trade: When entering the trade, I always look for a delta between 0.50 and 0.70. Delta measures the amount an option price will move for a given move by the underlying. For this trade, for every $1 decline in FXI, I will make $50 to $70 per contract.

The reason I chose a delta in the 0.50-0.70 range is for risk-management reasons. Choosing an option with a delta of $1 would be way too risky and potentially fatal if the underlying ETF moves in the opposite direction of your position. A delta below 0.50 would require a large move in the underlying ETF and I don’t want to wait for an extended move.

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Remember, RSI over the timeframes of two, three and five days takes advantage of short-term extremes. I do not want to be in a trade for longer than a week if I have to. When using the RSI indicator, my average trade lasts roughly 1-5 days, so choosing an option that would require a large move over five days is unrealistic.

So, back to the trade.

With FXI moving into a short-term extreme on 10/27, I bought FXI Dec 39 puts for $2.28. Two trading days later – after FXI dropped 2% - I sold these puts for $3.35 for a gain of 47%.

Again, I keep it very simple. Why would I attempt to create a complex options strategy when my strategy has a win ratio of over 85% with an average return of over 3-5% per month?

Why would I want to use an arsenal of gizmos and widgets, when I can use a simple tool like a hammer to get the job done?

Simple equals boring. And that doesn’t often entice traders, especially options traders. But I am not here for excitement. I’m here to provide a sound options strategy that makes people money over the long haul.

And that’s exactly what the RSI strategy has succeeded in doing.

The High-Probability Options Strategy

“Don’t take action with a trade until the market, itself, confirms your opinion. Being a little late in a trade is insurance that your opinion is correct. In other words, don’t be an impatient trader.” –Jesse Livermore

“What do you think about the markets here?”

That’s a question I often receive. My typical response? I don’t care. Okay, that may be a bit harsh, but it’s true. For the most part I really don’t care about the daily news that flows in and out of the market. I am an options trader. I trade strategies based off probabilities. I create statistical advantages based on my current market assumptions.

We must realize that knowing what’s going on in the news and knowing how to make money consistently are two separate things. For successful options investors it’s about your strategy, your logic and your process. It doesn’t matter what you think the market is going to do tomorrow. And that’s probably a difficult concept for the options newbie to understand.

You see, it’s not worth my time to absorb every financial story of the day. All I care about is when my indicators hit extremes. I allow probabilities - not the talking heads - to define my options strategies.

And this means that the strategy will endure periods of stagnation. Trades should never be forced. A forced trade is not a statistically sound trade. Again, this is a long-term approach to options trading and should be expected if you wish to bring in profits over the long-term.

Boring? Maybe to the aggressive crowd out there. But I’m more interested in the profitable trades. I’m not trying to be the short-term hero who tries to trade every scenario. I am confident in trades based on short-term extremes that have entered the stock market, or what I call “High-Probability trades.”

But I am also a realist. I know there is no holy grail in trading. However, I do know for certain that I have found a unique and concrete opportunity that makes a world of sense to me. And I trade it to make money over the long term.

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Furthermore, I realize that the less I trade, the better the strategy will perform over the long run. And the long run is what matters. This likelihood is what makes my High-Probability strategy unique and successful.

Patience is the key ingredient to the success of the strategy. Again, I can’t emphasize this enough: Forcing a trade is detrimental to any long-term options strategy.

So what is a High-Probability trade?

The High-Probability strategy is a short-term directional strategy that utilizes single calls and puts based on overbought/oversold extremes in the market. The strategy requires patience coupled with a disciplined approach. The strategy will produce an average of two to five trades per month with holding periods of one to 10 days. However, there will be some months when no recommendations are made. Again, the key to this strategy is patience.

This is our first, and simplest, widget. At times, this widget will hand us gains of more than 100% in fewer than a few days. Other times, we’ll gain “only” 5% to 50%.

And once in a while, we’ll lose a few percentage points.

The key is waiting for the appropriate scenario to recommend trades with a high probability of success.

This widget does not work for every market all the time – so we just have to wait until we have a good chance of success. As I always say, opportunities are made up easier than losses. So if you let a few pass you by, don’t dwell on what could have been. There will always be more opportunities around the corner. Remember, trading is a marathon, not a sprint.

The following is an example of a High-Probability trade:

Background: The market surged for eight straight days starting at the end of June. The surge lasted until July 7th, at which time QQQ (the Nasdaq ETF) had pushed into a short-term overbought extreme.

The RSI (5) reading in the chart below shows a short-term overbought extreme had been hit (green circle). I then checked to make sure my other proprietary indicators lined up to determine whether I should fade the move. In this case the move was higher, so I bought puts.

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The trade: With QQQ moving into a short-term extreme on 7/7, I bought QQQ 55 puts for $2.77. Two trading days later I sold the QQQ puts for $3.23.

So let’s review the benefits of the Options Advantage High-Probability Strategy

1. Short-term strategy that holds a position 1-5 days on average

2. Can make 3% to 5% a month.

3. Uses a diverse group of highly liquid ETFs

4. Only exposed to the market for a limited number of days

5. Section 1256 tax advantage

Options Advantage Credit Spread Strategy

As an options trader I am often asked about my favorite options strategy for producing income. In my opinion, the best way to bring in income from options on a regular basis is by selling vertical call spreads and vertical put spreads. These are also known as credit spreads.

Credit spreads allow you to take advantage of theta (time decay) without having to choose a direction on the underlying stock. That makes this strategy useful when you aren't confident about the future direction of the underlying stock or ETF.

Vertical spreads are simple to apply and analyze. But the greatest asset of a vertical spread is that it allows you to choose your probability of success for each and every trade. And in every instance, vertical spreads have both limited risk and limited rewards.

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My favorite aspect of selling vertical spreads is that I can be completely wrong on my assumption of the underlying and still make a profit. Most people are unaware of this advantage that vertical spreads offer. And it’s also an advantage that options have over stocks. Stock traders can only take a long or short view on an underlying, but options traders have much more flexibility in the way they invest and take on risk.

So what is a vertical credit spread anyway? A vertical credit spread combines selling an option and buying an option at different strikes. The spreads I trade typically last between 10 and 56 days.

There are two types of vertical credit spreads - bull put credit spreads and bear call credit spreads. Let’s look at both.

Bull Put Credit Spread

The goal of selling a bull put credit spread or vertical put spread is to have the stock close ABOVE the put strike you sold at options expiration.

Simply stated, you want the stock to stay above the short strike until the puts expire. That means the puts wilI expire worthless and you will retain the credit received up front. I typically sell out-of-the-money puts, so that I have some room for error if my assumption is incorrect.

Let me give you a simple example using a recent trade.

I placed an options trade using the highly liquid iShares Silver Trust (NYSE: SLV) as my underlying ETF. I prefer to use various ETFs to make this trade but you need to make sure that the ETFs are liquid, i.e. frequently traded, options on the stock in question. With silver trading at new lows I decided to place the following trade: Sell to open Aug11 SLV 28 puts Buy to open Aug11 SLV 26 puts

This spread created a total credit of $0.24 for a return of 12 percent if SLV closes above $28 at August options expiration. At the time silver was trading for roughly $33. While I was bullish on silver, I still wanted some downside protection, which is why I sold the Aug11 SLV 28/26 vertical put spread. Again, this is how I typically trade bull put credit spreads. I like to sell out-of-the-money puts, in this case the SLV 28 puts to give me some room for error. The SLV credit spread allowed for a 15 percent decline in the underlying (in this case SLV) before the trade was in jeopardy of becoming a loser. Again, as long as SLV closed above $28 at August expiration, I would make 12 percent on the trade. Amazing, right? Nice upside, with limited downside. This is why options and more importantly credit spreads are a necessity in any portfolio. If used correctly, they can be a powerful tool to enhance returns in your overall portfolio - even if the market slips significantly lower.

With July options expiration behind us and August expiration 32 days away, the credit spread that I placed was only worth $0.03. Remember, we sold a vertical put spread for $0.24, so if we want to take the trade off the table we would need to buy it back, in this case for $0.03. So we made the difference between the price or $0.21. Given the limited upside remaining, I decided to take all risk off the table and buy back the spread.

Here is the trade I placed to do this: Buy to close Aug11 SLV 28 puts Sell to close Aug11 SLV 26 puts for $0.03

Some of you might be asking why would we not just let the spread expire worthless, which would allow us to reap the entire $0.24?

The answer is that upside from here is very limited. While I did not think SLV would move 28 percent lower over the next 32 days, I was not willing to take a chance on silver breaking to new lows just to make an additional $0.03. Trading, particularly options trading, is about taking

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profits when it makes sense; and being prudent, staying disciplined and most importantly, looking at the long-term picture.

Trying to squeeze $0.03 out of a trade (which amounts to $3 per contract) just isn't worth the risk. The trade was successful, making 11 percent in just over three weeks. It was time to move on to the next opportunity. While I adore my High-Probability strategy, my favorite options strategy is the vertical bull and bear credit spread. Essentially, the strategy allows you make money even if a security goes nowhere. Most securities tend to stay in a price channel over short term periods, so using this strategy lets you make a high-probability investment that nothing extremely bad or good will happen to the underlying investment over the short term.

Bear Call Credit Spread

Here is another example of how I use credit spreads to bring in income on a monthly and sometimes weekly basis. This time I am using a bear call credit spread.

Fear is in the market. Look no further than the Volatility Index, or the VIX (otherwise known as the investor's fear gauge) to see that the fear is palpable. However, opportunities are plentiful with the VIX trading at 35 - especially those of us who use credit spreads for income.

Why? Remember, a credit spread is a type of options trade that creates income by selling options.

And in a bearish atmosphere, fear makes the volatility index rise. And, with increased volatility brings higher options premium. And higher options premium, means that options traders who sell options can bring in more income on a monthly basis. So, I sell credit spreads. As we all know the market fell sharply in the beginning of August 2011 and the small cap ETF, iShares Russell 2000 (NYSE: IWM) traded roughly 18 percent below its high one month prior.

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So how can a bear call allow me to take advantage of this type of market, and specifically an ETF, that has declined this sharply?

Well, knowing that the volatility had increased dramatically causing options premiums to go up, I should be able to create a trade that allows me to have a profit range of 10-15 percent while creating a larger buffer than normal to be wrong.

Sure, I could swing for the fences and go for an even bigger pay-day, but I prefer to use volatility to increase my margin of safety instead of my income.

Think about that… Most investors would go for the bigger piece of the pie, instead of going for the sure thing. But as they say, a bird in the hand is worth two in the bush. Take the sure thing every time. Never extend yourself. Keep it simple and small and you will grow your portfolio reliably. Back to the trade…

Basically, IWM could have moved 9.8 percent higher and the trade would still be profitable. This margin is the true power of options

So, let's take a look at the trade I suggested using IWM. IWM was trading for $70.86:

Sell IWM Sep11 78 call Buy IWM Sep11 80 call for a total net credit of $0.24

The trade allowed IWM to move lower, sideways or even 9.8 percent higher over the next 32 days (September 16 was options expiration). As long as IWM closed below $78 at or before options expiration the trade would make approximately 12.0 percent.

It's a great strategy, because a highly liquid and large ETF like IWM almost never makes big moves and even if it does, increased volatility allowed me to create a larger than normal cushion just in case I am wrong about the direction of the trade. So, selling and buying these two calls essentially gave me a high probability of success - because I am betting that IWM would not rise over 10 percent over the next 32 days.

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However, I did not have to wait. IWM collapsed further and helped the trade to reap 10 percent of the 12 percent max return on the trade. With only 2 percent left of value in the trade it was time to lock in the 10 percent profit and move on to another trade.

I am always looking to lock in a profit and to take unneeded risk off the table especially if better opportunities are available. I bought back the credit spread by doing the following:

Buy to close IWM Sep11 78 call Sell to close IWM Sep11 80 call for a limit price of $0.04

I was able to lock in 20 cents in profit on every $2 invested for a 10% gain in less than 5 days. Not too shabby.

Can We Make Money in Range-Bound Markets with Credit Spreads?

Since the beginning of 2011, the small cap ETF, iShares Russell 2000 (NYSE: IWM) had traded in a fairly tight range vacillating between support at $77.50 and resistance at $86.00.

The ETF was range-bound, so committing to a big directional play higher or lower was a high risk decision. I preferred to make a low-risk, non-directional investment, using credit spreads. As I have said before, we can also use range-bound markets to make a profit. How can credit spreads allow us to take advantage of a market, and specifically this ETF, that has basically stayed flat for seven months? Well, knowing that the market has traded in a range for the last seven months we can use this as our guideline for our position. Credit spreads allow you take advantage of a sideways or directional market while also giving you some breathing room if/when the range is broken. So, let's take a look at the trade using IWM, which was trading at $83.67: Sell IWM Sep11 90 call Buy IWM Sep11 92 call for a total net credit of $0.25

The trade allows IWM to move lower, sideways or 7.5 percent higher over the next 53 days (September 16 is options expiration). As long as IWM closes below $90 at or before options expiration the trade will make approximately 12.5 percent.

So let’s review the benefits of the Options Advantage Credit Spread Strategy.

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Because credit spreads involve selling options, time decay becomes your friend. Options buyers lose value as their options approach expiration. But this is not the case with credit spreads. As expiration nears and the sold option remains out of the money, the option’s premium loses more and more time value until it eventually expires worthless. If the spread expires worthless, you keep the credit received up front. And you don’t have to pay a commission to exit the trade.

In summary, the Options Advantage Credit Spread Strategy:

1. Is a one- to two-month trade that does not require constant monitoring of the market.

2. Works in all market conditions (bull, bear, directionless).

3. Can make 3% to 5% a month.

4. Uses a diverse group of highly liquid ETFs.

5. Enables you to determine your rate of success and the potential profit/loss and risk/reward before the trade is placed.

6. Section 1256 tax advantage

Seasonality

Seasonality in the market is often misunderstood and underappreciated. Seasonal tendencies exhibit repetitive price patterns that occur throughout the year. Being aware of these strong seasonal biases is an important tool that is often overlooked by investors and traders. Why would you not want to know about a particular period when an ETF has risen in 17 of the past 20 years?

Seasonal tendencies are best used as a forecasting aid. Seasonality alone is usually not a sufficient reason to place a trade. However, when compared with the current state of the market at the time the seasonal tendency arrives, the probability of a successful trade can be increased tremendously. So it’s important to always be aware of the market’s seasonal picture.

My preference is to use seasonal tendencies to assist me when making a short- to intermediate-term trade. By looking at market performance over a specific time frame - whether it’s a specific day, a month, etc. - you will start to see glaring seasonal tendencies. As you delve further into the seasonal calendar, you will start to notice tendencies around option expiration days, holidays, and the days surrounding the beginning/end of the month. Some months have greater tendencies than others (some are actually bearish). And obviously it’s to your advantage to know these types of biases.

Conclusion

After speaking with hundreds of investors, I discovered that the majority aren’t looking for a “get rich quick” scheme or a foolproof method of trading (we all know there isn’t one). What they want is a service with established capital preservation goals and historically proven long-term successful strategies. They want strategies that produce consistent, modest gains month after month, year after year. They also want to avoid unnecessary risks while using a methodical, tested set of rules that produce long-term gains.

The Options Advantage service was born from the collection of ideas mentioned above. After trading and back-testing almost every known options-based strategy, I fulfilled the requests of the investors and traders I spoke with and have identified several historically proven options-based strategies for long-term success in bull, bear and sideways markets.

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I encourage you to learn more about these strategies by joining our options newsletter service. Our service provides you with educational tools, research articles, and an in-depth look at our strategies, including specific trading guidelines as well as the research and back-testing data that went into developing these rules. I urge you to consider Options Advantage as a way to diversify your portfolio with minimal risk and a proven record of long-term success.

Kindest,

Andrew Crowder Chief Options Strategist Wyatt Investment Research

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Disclaimer

Options Advantage is owned and published by Business Financial Publishing, LLC, dba Wyatt Investment Research,. Business Financial Publishing is neither a registered investment adviser nor a broker/dealer. Readers are advised that this electronic publication is issued solely for information purposes and should not to be construed as an offer to sell or the solicitation of an offer to buy any security.

The views expressed herein are based upon our analysis of the issuer's public disclosures, and assumes both their accuracy and completeness.

The opinions and statements included herein are based on sources (including the companies discussed and public sources)

believed to be reliable and in good faith, but no representation or warranty, express or implied, is made as to Options Advantage their accuracy, completeness or correctness. We have not independently verified the information contained herein.

This information is not intended to be used as the sole basis of any investment decisions, nor should it be construed as advice designed to meet the investment needs of any particular investor. We encourage you to consult with independent financial advisors with respect to any investment in the securities mentioned herein. You should review a complete information package on all companies, which should include, but not be limited to, the Company's annual report, quarterly reports, press releases and all regulatory filings. All information contained in Options Advantage should be independently verified with the subject company.

The foregoing discussion contains forward-looking statements, which are based on current expectations, estimates and projections, and differences from such expectations, estimates and projections can be expected. Options Advantage is intended only for residents of the United States. Options Advantage is not intended for residents of the United Kingdom, and is not an approved publication by the Financial Services Authority in the UK.

The information contained in this newsletter is not intended to be a complete discussion of information regarding all of the current and/or intended business activities of the covered companies. Any opinions expressed in Options Advantage are statements of judgment as of the date of publication, are subject to change without further notice, and may not necessarily be reprinted in future publications or elsewhere.

Business Financial Publishing and its members, managers, writers and employees do not accept compensation from the companies discussed within Options Advantage. Business Financial Publishing and its members, managers, writers and employees, and their families from time to time position in the securities of the companies discussed within Options Advantage. These positions are subject to change at any time without notice. Options Advantage is a real investment portfolio that began with $25,000 of Wyatt Investment Research’s real money. Andrew Crowder invests this portfolio in the positions discussed within Options Advantage. Subscribers are provided with advance notice of every trade, as well as a trade confirmation once the trade is executed. The transaction log and current portfolio are available at the Options Advantage web site. Ian owns a position in every investment held in Options Advantage.

YOU SHOULD VERIFY ALL CLAIMS AND DO YOUR OWN RESEARCH BEFORE INVESTING IN ANY SECURITIES

MENTIONED ON THIS WEBSITE. INVESTING IN SECURITIES IS SPECULATIVE AND CARRIES A HIGH DEGREE OF RISK. YOU MAY LOSE PART OR ALL OF YOUR PRINCIPAL INVESTMENT.

We encourage you to review the financial and educational information available at the U.S. Securities and Exchange Commission ("SEC") website (http://www.sec.gov)) and the National Association of Securities Dealers ("NASD") website

(http://www.nasdr.com).

Copyright © 2012, Business Financial Publishing, LLC, dba Wyatt Investment Research.

Publisher of Options Advantage. All rights reserved.

This document is copyright © 2012 Business Financial Publishing, LLC. This document and all of the information contained herein cannot be reproduced, modified, or distributed in any other way without the prior written authorization from Business Financial Publishing.

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