A Safe (and Permanent) Income Alternative to Dividend Stocks

One day, the dividend bubble will pop. It might not be tomorrow, or next year – but when it happens, you probably don’t want to be heavily reliant on most of the heavily touted dividend stocks you hear about today.

Though I recognize that dividend investing is a great long term strategy, I’m not terribly interested in reaching for yield in stocks.

And we have alternatives.

You can bring in steady income using a small portion of the money that is just sitting stagnant in your account.

In fact, it’s a simple and straight-forward concept and one that I have been teaching self-directed investors for years.

Create Your Own Dividend

The answer: credit spreads. It’s the #1 strategy used by options professionals for a reason.

Credit spreads afford you the ability to create your own dividend…a monthly paycheck. When you sell a credit spread you collect cash (credit) up front while simultaneously transferring risk to the buyer

Best of all, selling credit spreads allows you to create your own income targets. And the sum of all of your so-called targets, when set properly, gives you a targeted monthly income.

Let me explain using a recent investment in Apple (Nasdaq: AAPL). (I talked about this trade in my latest webinar).

Over the last two months Apple rallied over 22%.

Will it continue its advance?

As an options trader and a self-directed investor I really don’t care. I only care about growing my portfolio through income generating strategies like the one I use in my Options Advantage service.

So, how can we take advantage of the recent price action in Apple?

Look no further than the bear call spread – a type of credit spread.

What is Bear Call Spread?

bear call spread is a credit spread composed of a short call at a lower strike and a long call at a higher strike. The nature of call pricing structure tells us that the higher strike call we are buying will cost less than the money collected from the sale of a lower strike call. It is for this reason that this spread involves a cash inflow or credit to the trader/investor.

The ideal condition is for the spread to expire worthless, thus allowing you to keep the premium collected at the time of the sale of the spread. In order for this to happen, the underlying will have to close below the lower strike call option that you are short.

The basic premise of the strategy is easy: you choose the probability of the trade. Increasing the probability of success will decrease your potential profits, but will increase your likelihood of success.

So, with Apple recently surging to over $700 and into a very overbought state I thought the stock was well overdue for a pullback, at least temporarily.

Again, now that I have an assumption in place, let’s move onto my strategy of choice…the bear call spread.

With Apple trading at $690, I wanted to choose a short strike for my bear call spread that met my risk/return objectives.

I prefer a win rate/probability of success in the 70%-95% range.  As such, I invested in the Oct12 750/755 bear call spread.

I like to give myself a decent margin for error, which obviously increases my probability of success.  For example, the 750 strike allows for a $50 or 7.1% cushion to the upside.

The Oct12 AAPL 750/755 bear call spread (check out my brief discussion of the trade) met my expectations as it brought in a credit of approximately $.62 or $62 per contract.

As a result:

  • The max gain on the trade – 14.4%
  • Probability of success – 86.6%

Apple would have to move above $750.62 for the trade to start losing value. As long as the stock price stays below $750.62 through October options expiration the trade is successful.

Nine days later I was able to take off the trade for almost a max gain. A 10%-12% in less than two weeks on a fairly conservative trade…not bad.

Credit spreads are my favorite way to trade options, particularly selling verticals. It's an extremely simple strategy to learn and arguably the most powerful strategy in the professional options traders' tool belt. And I can use credit spreads as often as I like.

As always, if you have questions, feel free to drop me a line at [email protected].


Andy Crowder
Editor and Chief Options Strategist
Options Advantage and The Strike Price

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