How Much Money Can I Make Trading Options?
Hey everyone this is Kirk here again at option alpha comm and in this video we're going to talk about targeting, your portfolio, returns and basically, figuring out how much money you can make trading, options now, at this point if you're new to our program, or are, just watching this video you should understand, or have a solid, understanding of. Where our edges, as options, traders and selling options the concept, that implied, volatility, is always overstated. And therefore. Options selling is always more profitable, an option buying and, before we start talking in depth about finding. And entering trades first we need to have a target, to shoot at or something to aim for so. Whether you're new to options trading or not one of the major questions, that people have are the following how, much money can I make or what kind of return can I expect so. I want to introduce you, to the concept, of using, targeted, returns or targeted. Probabilities. As your. Guideposts, for how you should be placing, the majority, of your trades in the future and, before we even get to that I think it's insanely, important, that we first talk about market, trade-offs because markets, are extremely. Efficient, and what I mean by that is that if you have a trade where, you are taking on less, risk then, you will have a lower, overall profit. And likewise, in markets where you taking on more risk you're gonna have a higher overall profit. It's just how markets work risk. And profit. Work, in the same direction mean lower risk lower profit, higher risk higher profit. Okay, that, also means that with regard, to options, trading your, probability. Of winning and your profit, potential work, in different. Directions, or in the opposite direction and, what I mean by this is that when, you, increase. The probability of winning on a trade so, instead, of having a 70%, chance of success you, increase, that chance, of success to 80%. Your, profit, potential goes, down accordingly. Again the markets are efficient here so when you're gonna win more, often your. Profit, potential goes, down okay, and this. Works in Reverse too so if your probability, of winning goes down meaning you reduce, your probability of winning from say 80% to, 50%. Then your potential profit, on those. Trades that are maybe 50%. Of the time gonna win or not are gonna be higher when you do win so your profit potential might be a little bit higher this. Is like a lottery ticket I use, as an analogy, all the time your probability, of winning lottery. Ticket is insanely. Low I mean practically non-existent right, but. Your profit, potential is really really high because it's, in direct. Correlation and, relationship, with the probability, that you're gonna win so it's all efficient and unfair okay now, the reality is and this is what nobody tells you in this business but I want to go through here with you today is that you can target whatever. Return you, want annually. In your portfolio, you want a 10 percent return a 20, percent return a 50 percent return but, just ask yourself, the following how. Much risk will, I need to take to make a 50, percent, return, again. Because there's no free lunch it's, not that you can make a return without taking some risk so, how much risk will you need to take to make a 50 percent return or more, importantly, can you handle, the volatility, in your account trying to get there I think that's the more important question that, people need to ask see a lot of people shoot for the really high percentage.
Annual. Return. On capital but, they can't handle the volatility, they don't have the persistence. And confidence, to get there okay now I want to use this graph as a quick, visual aid because I think it's gonna represent the point that I'm trying to make here with your, targeted, returns is that again, you can target anything, you want it's just can you handle, the volatility, and the risk that comes with that trying. To get to that you know target whatever you want to wherever, you want to be at so, if your target let's say is 10%. Annually, which is very, good and in all cases beats, the market averages. Across the board so, 10% annual. Return, on your trading which i think is very very. Doable right your, account, portfolio. Might start here, at 0 on, some timeline though this timeline doesn't matter whether it's days weeks years it's. Just the concept, that we're trying to prove here but, your account balance might start with a zero percent return, as you just start funding in and then, the first month that you start trading maybe you make 5% and the, next month maybe you make 3%. And the next month you make four and then you make seven, and then, maybe one month you lose maybe, eight percent, whatever the case is okay you can see that there's definitely some volatility, as you're, working towards, your ten percent target. And you can get there over time but, you're gonna have a certain amount of volatility in your account a 10, percent return is, not, taking, on a substantial. Amount of risk you're not taking, on an insane, amount of risk to, get to a 10 percent return and actually we're gonna prove that here later on the video with some actual real numbers, and calculations but, you're not taking on an insane amount of risk to get to 10 percent and that means that yes you're gonna have some losing months but most of the time the vast majority of your trades and your potential. Winning months are gonna be above, zero meaning they're gonna be profitable, on some level now. Let's take the opposite example here and let's say that we're shooting for a 50 percent return per year now, think about this a 50 percent return per year means you're taking on at least five times more risk right probably more because it's gonna be exponential, risk to, actually earn 50, percent per year you're gonna try to you know basically make, a ton of money but you're gonna have to increase, the amount of risk that you're making per trade so, again you start off with that same account balance at zero with not making any money the, first month maybe you make 10 percent the. Next month maybe you lose 10 and the next month you lose 20 and then, the next month you make 10 right, so now you can start to see that your, account balance, although you may get to 50 percent eventually. The, fluctuations. And the volatility, in your account trying, to hit that 50 percent target, is going to be much greater and, the, problem that I have with shooting, for a target that's too, high even, though I think you can do a 50 percent return is that when the times when you lose money are you, going, to be the type of person that's willing to hold. Through, those, really, tough times where, you could potentially lose 30, 40. 50. Percent of your account over. The course of a month or two months or a year and then. Try to trade, back from that time period and I don't think that many people would do it I don't even think that many people want, to do that because honestly. Think about it if you invested, say $10,000. And, over. The next six months you could lose half of that would you really be willing to continue, to stay on track be trying to hit that 50% target, and I doubt many of you actually would even though some, of you might now right now and during this video say sure I'll definitely, stay on track to hit that 50% target, I doubt, that's the case okay in my personal opinion I'd, shoot, for around 15, to 20 percent that's where we've historically landed, I'm actually landed around 18 percent but, we shoot for anywhere between 15.
And 20 percent return again I'll show you how we kind. Of come up with those numbers here in a second because for me I feel like that's a good, amount of volatility in my account it definitely moves and yeah I have the occasional month where I lose a little bit of money but most of my months are higher, meaning, most of my months are profitable, and I much rather see a consistent, kind. Of conservative income, stream so, the question from here naturally, becomes okay well we know that we can sell options at any probability. Level and that, we want so we can sell options at a 60%, level an 80%, level 50. What, is the optimal. Level for return, and risk or margin, use well. We've done before is just go back and look at one IWM. Naked, point now we did this a little while ago and this, is not the one-size-fits-all. You know example, here but it does prove the point that we're trying to make with, regard to the optimal. Or what we believe to be the optimal. Probability. Level for selling, options now, what you can see here on this chart is that there's different probability, levels that we looked at for some naked IWM, traits so sixty seventy eighty and ninety. Percent chance of success okay, it's so the likelihood that you win on the trade now, naturally. With, a 60, percent chance of success you make the most amount of money if you're right because again the markets fair so lower, probability, of success higher, potential, profit, or credit same, thing starts, to happen as you go further out in probability, the, amount of credit that you make as you go further out declines, because as you increase your chance of success you, decrease, the total, potential profit, that you make okay so now it becomes where, do we find that may be optimal. Difference well the, difference in, credit between six, and seventy, in this, case was a almost of 30 percent difference, in credit, okay the difference between. 60. Here, or I'm sorry the difference between. 166. Here and 112. Here was, again another. 32%. Difference and now, the difference between 112. And 47. Was, a 58%. Difference. Okay so you can start to see that your credit starts going down exponentially. At first it goes down, 29%. Then the next 10%, jump up goes down to 32, and then the next 10% jump up it goes down almost, 60%. Okay so you do have the point at which it doesn't. Make sense to increase, your potential, profit. Or your probability, of profit because, your money. That you could make is going down exponentially, now. The margin that's required is here and you can see the margin that is required, on each trade goes down as well because the brokers know and as you sell further out options, as you're, increasing, your chance of success you, don't have to cover as much margin because there's not as much risk in the trade now, if we look at just the return on capital which, is basically the credit divided by the margin, you can see that the return on capital as well, goes down okay so it's all making sense that increased. Probability of success lower. Total, credit lower margin, lower, return, on capital but. What's interesting here, is that the difference between return, on capital for, the first two so jumping from 60%, to 70%, was. A 17, percent difference. In return on capital, meaning, the difference between 11, and, 968. Here the. Next 10 percent jump level so from 70, to 80 percent was. A 19, percent drop, in return on capital and then, you can see again, just like what happened with the difference in credit once, we jump from 80 percent, winners to 90, percent winners the, return on capital dropped, a dramatic, 41 percent okay, so what's really important, here to understand, is that there, is a point, at which having. 90. Percent winning trades is actually. Taking, on potentially. Too, much risk and not getting. In enough credit or taking in enough credit to compensate, you for that risk and you can see that break even points starts somewhere around 80, and starts to head out towards 90 so, for the sake of what we do here at option alpha we basically, base most of our pricing, on a one, standard, deviation. Probability. Move and, we think that gives us the most optimal. Use of capital okay, that's around a 70%, chance of success when you start building out traits so, whether you're doing one.
Side Of trade or whether you're doing an iron Condor, or butterfly. You want to try to build those trades to have about a 70%, chance. Of success and again that's what we've found you. Know looking at multiple, pricing, scenarios, over the last eight years that. Gives you the best, use. Of capital the, best return and doesn't, sacrifice your, win rate too much okay, and definitely, not anything under, 60% that's. At least where we stand now as, we, start to transition to figure out how, much money we need to be making on a yearly. Basis, what we do is we break that down into, basically, two, components, okay so, we basically break down how, much, allocation. Your overall, portfolio is. Invested. In options, now we have here different allocations, just to kind of prove the point but let's. Say, for example that of all, the money that you have available to trade. 5%. Over the course of the year is invested, just in options, trading so if you, have a hundred thousand dollars that would be five thousand, dollars of your, hundred thousand dollars is invested. In options, trading okay if you, have a ten percent allocation that be ten thousand dollars under a hundred thousand dollars etc, etc etc now. The reason that we capped that at 50 is because we never suggest, really that you go over 50 or 60 percent of your total, account, balance that means if you've, got a hundred thousand, dollars we, never suggest, that you invest more than say, 50 or 60, thousand dollars in, options, trading you just don't need to invest the, full hundred thousand dollars to make a return, that's, extremely. Great on the full portfolio okay, we feel like you can you know use options. Really wisely use the leverage, that options, give you on that fifty to sixty thousand, dollars and still make a great return, on the overall. Thousand dollar portfolio okay. Now, the other thing that we look at is we look at return on capital per, day okay so and again we'll go through a bunch of examples here but there's, different return on capital levels. Per day and so this is really, what you want to start thinking about it's like where do you want to target, your return on capital again, the, more risk that you take on or the, higher the return on capital that you shoot for you just have to understand you may not win as often and you, may be taking on more risk which means that more volatility, in your account like we talked about before but. For example let's say that we want to generate. 10%. Or around 10% return on our overall. Portfolio so, this is that whole hundred, thousand dollar portfolio well. We would need to earn about, 0.3. Percent, return, on capital per, day for the entire year, on just. 10% of our account so, again if we just invested, a thousand. Ten, thousand, dollars of our $100,000 portfolio, just that, ten thousand dollars and that ten thousand dollars was earning, 0.3% per. Day for the entire year, then, at the end of the year our overall, portfolio would, make a ten point nine percent okay. So that means we still left ninety, thousand dollars in cash and now you probably can, start to see why options. In my opinion, are extremely. Profitable. And, less, risky, than trying to invest a hundred thousand, dollars in stock and hoping you make 10% investing. The entire amount of money in the market okay, so this gives you a really good basis, for where, you want to start you know trading, and, basically. Targeting, your probabilities. And your return so again we're gonna go through an example here in a second in, a my opinion, I usually, like to focus on things that are in less than, 0.25. Percent, per day because I want to be at a higher, probability, of profit level, meaning, that I want to have a higher chance of success on, the trades that I make so I keep my win rate high so. I don't really focus on something that has a insanely. High return, on capital per, day but, I'm also allocating. A lot, of my money to the, market every single day every single month and every single week. So usually, we've got about you know 30 to, 25 percent our portfolio, allocated. At any given time and so, obviously, that gives us you know kind of the numbers that were shooting for us so somewhere around 15, to 18, 20 percent per year is what we're targeting, so. In this example today, I want to go through a bunch, of different pricing, scenarios, for, IWM, now it's really important, as we go through this that, you really take the time to understand, this because this, is going to be an integral, part in how successful you.
Become Trading, options if you don't understand, again the math behind how. We get to whatever percentage. Return we're targeting then, you really won't, know and, won't have the confidence to continue to make trades over and over again even if you, have a bad month or two bad trades or three bad trades the, numbers always work out to be profitable, it's just a matter of making, small trades and making them often enough so these numbers work out okay so in this example here we just took a screen shot just, the other day of IWM, this. Is a the. Russell ETF, so insanely. Liquid, great, options, very, tight markets, and at, the time that we took this screen shot the IWM, was trading at 106, 92, okay, so basically 107. The, May contracts, at the time which were 57. Days away that's at 57, right there 57. Days away basically. Had these options, pricings, across, the board so these are the puts on the right side and then we have the calls on the left side now, what we did is we basically say okay let's start, with just naked selling. A 102. Strike. Put option down below the market okay so again stock was trading at about 107, and we're, gonna naked sell a 102, put option down below the market those. Put options were trading, for about 173. Each, okay. And you can see that the probability, of those options being in the money or the probability of those options losing. Based, on that strike price was about 31 point four seven okay, so, the likelihood that you actually made, money on this trade was about 70 percent and the reason I say about 70 percent is because actually, the break-even point since we collected a dollar 73. Was, actually closer to around a hundred alright so but just for the sake of argument making. Our numbers, simple in the mouth simple for us we, are gonna say that there's about a 30% chance that you lost money I was 70% chance that you made money and again that's based on probabilities. Historical. Pricing everything that we know about iwi moved, moves. Any move it's made in the past the magnitude, the timeline, for, the next 57, days there's, only a 30%, chance that it closes below 102, okay, so that's a high probability, trade that weekend so when we bring up this order dialog, box that basically confirms, everything, for the order we can see here that the max profit on this trade is, the 172, credit that we can take in again this is selling the may 102. Puts at 172, dollars each now, the margin required, for just one of these contracts. Is. 1645. Okay, so that's the margin, right there that's required to, get into one of those contracts, are basically the risk that you have to put up so, if we take 172. And we divide it by 160. 1645. We basically get an initial. Ten. Point four five percent return, on our investments. If this trade works out then. We basically make, ten point four or five percent, but. We know that this trade is not going to work out a hundred percent of the time so we have to take our ten point four five percent ROI and, times, it by the probability of success that, this trade has which is basically, seventy, percent so.
Only 70, percent of the time are we going to actually look at making somewhere. Around 10.45. So. Our effective, return, after. We factor in the probability, of success is seven. Point three one percent. Again. After, we factoring, that seventy percent chance of success okay. So now we have our return on capital after, we, have calculated, the return, or. The probability of success we, now divide that, number by fifty, seven that's the number of days left. In the contract, expiration, period, so, again if we go up here you can see that 57, is right here that's the number of days left and that. Gives us basically our, return, on capital per, day so, we're basically going, to expect, to make about. Point one two percent return. On capital per. Day for, the 57, days that were in this trade. Now if we assume again, and this is the assumption that we make trades like, this all the time all year which is very easy to do so it's not hard to do a lot of trades like these if. We assume that we make this type of trade every, single day all year, have a trade on like this that makes one point zero point one two percent return. On capital per, day all, year, long and we only invest. 25. Percent, of our accounts, okay so again this is where we get back to what we talked about earlier we're, leaving. Seventy-five. Percent of our account just, in cash in this example so you can increase your investment you, can decrease it whatever you want to do but, in this case we're just assuming 25. Percent of our account is invested, in something. Like this okay so we'll scale up the number of contracts, or, whatever we need to do to get to 25 percent of our account invested. In a trade like this so. We take the 0.12, percent return. On capital per day times, 365, days, a year, but we're only making, that on 25 percent of our account that's invested, and that gives us eleven point seven one percent, annual. Return, okay, hopefully, I didn't lose you if I did go back rewind this video go through it again we'll go through another example here, okay and again the reality is is that that is a pretty powerful. Return. When, you think about the fact that you're only investing, 25 percent of your account so, if you've got a hundred thousand dollar account, seventy-five.
Thousand Dollars of your money is sitting, in cash not, at risk at all probably earning a little bit of interest from your broker and the, other 25, thousand dollars is actually earning a much higher return on capital that. Compensates, for the other 75, percent that's sitting in cash, okay so again this is why I love options, trading because, although we don't want to ever invest, that hundred thousand dollars we still want to be smart and conservative, with our money we, can still have a lot of money left over we don't have to risk way, too much money investing. In stocks and trying to earn a 10%, return investing. That hundred, thousand dollars okay so, now let's look at a different example so in this case let's. Actually go down and look at a trade that has an even higher chance. Of success and just to show you how these numbers work out again like, we talked about before a risk the reward. Is definitely efficient, in the market so you can't get something for free without giving up something so, let's actually look at selling just the 96. Strike, put options now obviously, these are much lower than, the 102 options, and you can see the likelihood, of these, options going in the money is about 15%. Alright so, 15.1. I'm just rounding down just so that we can use, you know simple numbers and simple math here so, about 15% chance that this thing goes in the money so about 85, percent chance, that it never hits, the 96, strike and again that's logical, that makes sense because there's, about a 30%. Chance it hits the, 102 about. An 15%. Chance that, it hits the 96. Okay because that's a much lower strike, so. If we were to sell. Those 96. Strike, put options we, could basically collect, a profit. Of about, $77. Now, you'll notice our margin, is lower as well because this is a less risky trade the brokers recognize, that they, realize, that you, have a higher probability of success so they carry less margin to keep this trade or your buying power affect is dramatically, less now. We have a return on capital on, the raw basis, or kind of the the front basis, of 7.39. Percent, now this is different. Than our ten point four or five percent that we had for the initial, or original train so, now again we do the same types of calculations, that we did before we take that seven, point three nine percent return on capital we. Times it by the likelihood that we're actually going to win and make that money of 85, percent and that, gets us kind of an after, return, and probability. Of. Six point two eight percent.
And Again we take this number divide, it by the number of days then, we're going to be invested, in this which is 57. Days so, we're basically looking at a point 1 1 percent, return, on capital per. Day for, a trade like this now. Again we take that return on capital assume, and yes this is an assumption that we make the, same type of trade over and over again all year long we have the same amount of money invested in the same type of trade all year long and again, it's very easy to find these types of trades they're not hard to find so. We assume that we have an 11%, return our point 7% return on capital per day times. 365, days, a year, but, we're only making that money on 25%. Of our account that's invested, again we've got 75%, City in cash that, gives us a ten point oh six percent, return annually, okay so very easy to see how you can just make, a couple simple trades, with. Minimal, risk without investing, a hundred thousand dollars of your money and still, generate a very, decent. Return, trading, options and again obviously we're, looking at a tenth, you, know kind of 12%, return. So. What you should have noticed is that obviously the market is efficient, when your probability, of success went, up from, 70, to 85 percent your, annual, return rent, went down accordingly, went, from twelve point seven one down to I, forget, what the RM love sorry eleven point seven one down, to ten point oh six okay now. Let's look at something a little bit different so instead, of looking at just a naked. Trade, which is just selling, the 102 s or selling the ninety six let's. Actually look at something a little bit different that is a credit, put spread so, let's look at selling the 102 s and then buying the, 100. Strike puts and creating, a puts print now, again this is gonna have about the same probability of success as the selling of the one of twos because. It's still you would still lose if the market goes down below, 102, that's, no different but now you have limited risk, by, doing this crying put spread so, again in this example we're, selling the 102 s we're buying the 100 strike puts to create a vertical credit, put spread we, basically cap, our potential, profit, at this at this point to just $40.
But, Notice that our risk, is dramatically, reduced from, thousands. Of dollars potentially to. One hundred and sixty two dollars per. Spread, that we're trading now, on the outside this is a higher, return, on capital so 40 / 160, - we're, making twenty, four point five percent return, on capital okay, now if we continue on with this example again taking, that twenty four point five percent ROI, times. The likelihood that we actually win which is 70 percent, that, gives us kind of that after, probability. Being factored, in return. Of seventeen point one five percent. /. The number of days that were in the trade about 57. And so, we're looking at basically a point three, percent return, on capital per. Day, that. We're investing in this in this particular, security. Okay now, again we take this and we say assume that we make this type of credit spread trade time, and time and time again over the entire year we're, looking at a 30 percent return 0.3, percent return on capital per day times, 365, days, in the year but. We're only making, that money on 25%. Invested, that leaves us with a twenty, seven point five percent annual. Return, okay and again, if we go back up to our chart that we had before if you, look at basically. A point, three, percent return, on capital per, day with, that 25 percent return, or. 25 percent of your account actually invested, you come up with virtually, the same, 27. Percent return. Annually. On the entire amount, of money that you have invested, okay, so, again you can see how this actually works out really well doing the credit spread, versus. Doing the short put but, don't mistake this, credit spread automatically. As being a better trade necessarily. Yes, you, did increase, your ROI and, your annual return, but, you gave up 76, percent, of your total dollar, profit, now remember higher ROI you, have less risk in the, trade but you gave up something and in this case you made only $40. Versus. Making. 172. Dollars now, it's funny because I'll often ask people if they want the highest ROI or the highest dollar profit and there, is a difference now, there's no right answer here but it is important, to understand, the trade-offs okay so you can absolutely go, after more of the credit spreads scale.
Up Sell, more of the credit spreads or you. Can do more, of the naked positions, right and do less contracts, you, do more credit spreads you, have a lower dollar profit. Per, trade, higher. Commission, cost because you'll probably have to do 10 or 20 of those to make up for some of the short, premium, naked positions, again, it's, a trade-off that you have to make and. Have to decide on but I'm just, showing you that it is, entirely. Possible to. A very, decent, return. Trading, options with a small, amount of your money invested, even. If you're doing naked. Positions, or if you're doing a credit, spread trade which, anybody, can do I mean like the reality is I go back to this example, anybody. That's out there that's starting out can, take a trade, that has a hundred and sixty two dollars of, risk that is a very. Very, low, risk, threshold, you, can take this trade if you've got an account of $5,000 or $3,000, that's a trade that you can take and the, same thing is you know you can just scale up that trade or do some other trades well I'd not the strikes there's a million different things that you can do to. Increase your potential, profit, you, know take on a little bit more risk, so, less contracts, okay so there's no right answer here as to what is necessarily, better but you just have to understand that the market is fair. And efficient so. If you take on more risk you potentially. Could make more money but you sacrifice, probability. Of profit etc, etc etc okay so, I always say you, will hit what you're aiming for we. Highly, suggest you, pick one, probability. Target, say 70%, and place, all of your short premium trades at that same probability. Level over, and over again okay as a guidepost, if you, target trades, around 70% you should hit anywhere. Between 50, 15. And 20% per year depending on the types of trades you're doing how, much money you're investing in the market etc. Etc okay, we, target, around the 70% chance. Of success for every single trade that we do on the short premium side that's just where we hang, out that's our target, that we're always going, after so that we're consistently. Shooting at the same, probability. Level and again that helps build confidence it, helps to build consistency. And persistence in your trading I think, it's really important that you take the time now to really think hard about, where, you want to be in your trading I would, highly, suggest that, you avoid. Trying. To go after the. 92%. The even 50%, return, per year type trades until. You get really. Really comfortable with, an options, trading system start. Small you can always scale, you can always increase, your, risk but, if you go for, the, big homerun shot in the beginning there, is a good chance that you have a really, bad trade, because, you took on too much risk and you, can't ever recover, from that or it takes you a long time to recover from that ok so, I'm not saying that you can't do that I'm not saying that guys out there you know can't make a lot of money trading options I'm just saying no what, type of risk you're, going to be taking on to get to that level ok so, as always hope you guys enjoyed this video this was a really fun one for me to do hopefully it was something different that you've never seen before I'd love to know your comments your feedback if you loved this video please, share, it online sent to a friend a co-worker or a family member help, us spread, the word about what we're trying to do here at option alpha until, next time happy trading.