TD Ameritrade, Fidelity, Charles Schwab, and E-Trade are following in Robinhood's footsteps and offering commission-free trading on all stocks, ETFs, and options trading! This presents an options trader’s paradise and serves as a great time to start trading options as these commissions are no longer cutting into your profit margins. This is vital since maximizing the number of trade occurrences is one of the many reasons why options trading is so effective over the long-term. Over the past 14 months, an options-based portfolio demonstrated the effectiveness of this strategy against the traditional stock-picking approach.
Primarily sticking with dividend-paying large-cap stocks across a diversity of tickers that are liquid in the options market is a great way to generate superior returns with less volatility over the long-term. Over the past 14 months, 343 trades have been made with a win rate of 87% and premium capture of 58% across 70 different tickers. When stacked up against the S&P 500, an options strategy generated a return of 10.3% compared to the S&P 500 index which returned 8.2% over the same period. These returns demonstrate the resilience of this high probability options trading in both bear and bull markets (Figures 1 and 2).
Commission-Free Cost Savings
Over the past 14 months, over 300 trades were placed, and commissions were paid on opening and closing these trades (unless I closed the position for less than $0.10 per contract). For a given block of 300 trades, the commissions incurred are $5 per trade, translating into $1,500 to open this block of trades. Worst case scenario, another $1,500 was incurred on closing this block of trades resulting in a total of $3,000 in commissions being paid. It’s critical to mitigate these commissions when running an options-based portfolio since these costs will erode profit margins. Circumventing $1,500 - $3,000 over the course 300 trades can make a meaningful difference in any given portfolio while providing flexibility to close trades now that commissions are no longer a deterrent.
Life Insurance and Options Trading?
Insurance companies sell policies based on actuaries and risk factors, then price these policies to their advantage. Insurance companies are betting on probabilities across insurance products and sell overpriced policies above their expected losses. The insurer agrees to pay out a specific amount of money for a specific loss (i.e. death). In return, the insurance company is paid monthly premiums and based on this risk-based revenue model; it’s a very profitable business. Insurance companies sell policies with a premium cost level that maximizes a statistical edge to the insurance company’s benefit. The goal is to collect premiums over the course of the policy and never payout on the policies they sell to you. So, the probability of paying out on the policy is very low while the premiums received, over the policy lifespan will exceed your total benefit.
In terms of life insurance, it’s the probability that you won’t die before your predicted lifespan, so the insurance won’t have to pay. The insurance company assumes you’ll die before the model predicts and will charge you more money via premiums upfront. In order to spread the potential payout risk, the insurance company will sell as many policies as possible to collect as much premium income as possible. In short, insurance companies have found a way to statistically place the probability of never paying out on these policies they sell to you in their favor.
Running Your Portfolio Like An Insurance Company
Options trading is much like the insurance example above. I receive premium payments (policy payments) in exchange for selling options (insurance). I sell these options with a statistical edge (underwriting) and a high-probability of winning the trade (insurance won’t have to pay). Occasionally, options move against you (death occurred) and you’re assigned stock (insurance is paid out) however in order to spread the risk of being assigned shares, options (insurance) are sold across a diversity of tickers that include both stocks and ETFs with varying expiration dates and optimal sector exposure. Additionally, risk is mitigated by appropriate capital allocation, position-sizing, and holding cash reserves in the portfolio.
Maximizing Number of Trade Occurrences
Maximizing the number of trades is essential for any options-based strategy. Placing only 10 trades or 50 trades over a given time period is simply inadequate for an options-based approach. Trading through all market conditions at a specific probability of success level, given enough trades and time, the probabilities will reach their expected outcomes. This maximizes the number of shots on goal, and over a long enough time period, these data will be smoothed out over the various market conditions to reach your expected probability of success. To achieve the expected probability level, hundreds of trades need to be placed and closed before the probabilities really begin to play out. As these trade data grow in size, plotting all of your trades over time, you’ll see the numbers align more and more with your expected probabilities. Taken together, trade as often as you can at your desired probability of success to achieve the win rate of interest (Figure 3).
Maximizing the number of trade occurrences, position-sizing, diverse sector exposure, trading stocks, and ETFs and managing winning trades is essential for an options-based portfolio to succeed over the long-term. Now that all major brokers have transitioned to a commission-free trading model, an options-based portfolio can be even more lucrative. Now that options traders can circumvent all options related commissions, profit margins can be maximized.
Options trading allows one to profit without predicting which way the stock will move allowing your portfolio to generate smooth and consistent income month after month since options are a bet on where stocks won’t go, not where they will go. Selling options with a favorable risk profile and a high probability of success is the key. Options provide long-term durable high-probability win rates to generate consistent income while mitigating drastic market moves. I’ve demonstrated an 87% options win rate over the previous 14 months through both bull and bear markets while outperforming the S&P 500 over the same period by a wide margin producing a 10.3% return against an 8.2% for the S&P 500 with a lower risk profile. Taken together, options trading is a long game that requires discipline, patience, time, maximizing the number of trade occurrences, and continuing to trade through all market conditions with the probability of success in your favor.
Disclosure: The author holds shares in AAL AMC, GE, KSS, SLB, TRIP, USO and X. However, he may engage in options trading in any of the underlying securities. The author has no business relationship with any companies mentioned in this article. He is not a professional financial advisor or tax professional. This article reflects his own opinions. This article is not intended to be a recommendation to buy or sell any stock or ETF mentioned. Kiedrowski is an individual investor who analyzes investment strategies and disseminates analyses. Kiedrowski encourages all investors to conduct their own research and due diligence prior to investing. Please feel free to comment and provide feedback, the author values all responses. The author is the founder of www.stockoptionsdad.com where options are a bet on where stocks won’t go, not where they will. Where high probability options trading for consistent income and risk mitigation thrives in both bull and bear markets. For more engaging, short duration options based content, visit stockoptionsdad’s YouTube channel.