Weekly Income Generator Using S&P Options

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weekly income

 

Weekly income generation using SPX options. Take the current SPX price and the VIX. If SPX moves 1/4 standard deviation away, sell a spread from the other side at the 1/2 standard deviation.

Example: If SPX moves down -1/4 standard deviation, then sell a call spread from the other side at the +1/2 standard deviation.

Weekly Income Generator Using S&P 500 Options

This strategy has a 74% success rate.

Underlying: SPX

Formula:

1 Standard Deviation = Underlying Price * (VIX/100) * SquareRoot(Trading Days to Expiration/Trading Calendar Days)

I use Trading Calendar Days = 252

Trade Entry Guidelines:

  • Since it’s weekly income, we’ll do this every week. Use Wednesday’s closing VIX to calculate a 1/4 and 1/2 standard deviation move for the SPX.
    • Let A = 1/2 StdDev = Take 1 StdDev calculated above and divide by 2.
    • Let B = 1/4 StdDev = Take 1 StdDev calculated above and divide by 4.
    • In this case, let’s pretend that
      • SPX = 2500
      • 1 StdDev = 100
      • 1/2 StdDev = 50
      • 1/4 StdDev = 25
  • Use Thursday’s open for the SPX.
    • Add A and B to get the upper 1/2 StdDev and 1/4 StdDev
      • Upside 1/2 StdDev = 2600
      • Upside 1/4 StdDev = 2550
    • Subtract A and B to get the lower 1/2 StdDev and 1/4 StdDev
      • Downside 1/2 StdDev = 2400
      • Downside 1/4 StdDev = 2450

Graphically, we end up with something that looks like this:

weekly-options

  • To generate weekly income, you’ll have to do this every week. Start looking to enter trade on Thursday morning for the options expiring next week. If the market rises or falls a 1/4 standard deviation, that is an entry trigger.
    • Next, determine the following: If the market went up 1/4 standard deviation then sell a put credit spread at the 1/2 standard deviation mark you calculated from step 2. If the market goes down 1/4 standard deviation then sell a call credit spread at the 1/2 standard deviation move above the market.
    • In other words,
      • if SPX goes up to 2550, sell a put spread around the 2400.
      • if SPX goes down and hits 2450, sell a call spread around 2600.

Keep in mind this may happen on Thur or Fri of the same week or Mon, Tue, or even Wed of the following week. The closer you are to expiration the smaller the credit you will get but that will be offset by a higher probability of profit. The higher probability of profit is what provides weekly income, despite it being small.

Exiting the Trade

  • If the market retraces going against you to the 1/4 standard deviation mark price you calculated in step 2 then immediately exit the trade regardless of profit or loss in the trade.
  • E.g.
    • If you sold a put spread around 2400 and SPX reverses down to 2450, EXIT.
    • On the other hand, if you sold a call spread around 2600, and SPX reverses up to 2550, EXIT.
  • If the market does not retrace against you then just let the options expire worthless for max profit.

Risk Management:

  • The risk management for this position is built into the guidelines. The risk management is taking the trade off if it goes against you to the 1/4 standard deviation mark price.
  • If you prefer to try and “manage” the trade by using long options or spreads to hedge or even rolling into a butterfly those are all options you can experiment with. But I like to keep it super simple with my trading so I just tend to be more selective with my entry and simply put on the trade and either take it off or let it expire worthless. Since this is supposed to provide weekly income, managing a trade may defer that or overlap with another week.

With regard to Days to Expiration you can use the actual number of days to expiration or the number of trading days until expiration. Using the actual number of days will mean you are using a larger input number and therefore will have a larger deviation number. Using trading days until expiration will mean a smaller input number and therefore a smaller deviation number.

Other Factors to Consider:

There is also small debate on whether or not you should use 365 (number of days in a year) or the number of trading days in a year which is 252. This is up to you when determining your weekly income volatility. Using 365 will produce a smaller deviation number. Using 252 will produce a larger deviation number.

A larger deviation number will result in a less aggressive trade as you will be selling a short that is further out of the money. This will mean less profit in the trade but a higher probability or likely-hood of profit. I usually prefer higher probabilities for weekly income. But this is up to you as the trader.

A smaller deviation number will result in a more aggressive trade as you will be selling a short that is closer to the money. This will mean more profit in the trade but a reduced probability or likely-hood of profit. Lower likelihood of weekly income may result in losses and drawdowns. But he losses will be lower in value.

The original presentation regarding this play by Jim Bittman can be found here

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