Option trading is always risky and super aggressive, right?

Wrong.

In fact, when you combine multiple options into one trade (an option spread), you can achieve a defined risk trade, where you know the maximum you can lose. It can be as low as $50.

In addition, you can use options to generate income. Here’s how:

First, understanding how options work is important.

Remember that options derive their value from two sources:

Intrinsic Value: This is the value the option would be worth if it were to expire in 1 minute. For calls it is simply the price of the underlying stock minus the strike price. For puts it is the strike price minus the underlying price. A call option with a strike of $20 on a $25 stock has $5 in intrinsic value.

Extrinsic (Time Value): This is the value attributed to time. Because options can be exercised anytime before expiration date, time is important. The stock can still move between now and then, so the more time you have, the more time value your stock has. If a $20 strike call on a $25 stock is trading at $7, it has $5 in intrinsic value and $2 in extrinsic value.

That extrinsic value is what we’re after when we trade options for income. Because we KNOW that on expiration day, extrinsic value WILL BE ZERO, we can sell the option and collect the extrinsic. The cost of doing this is the risk of the intrinsic increasing. If the stock moves against you, you can lose money. To manage this risk, we can buy a similar option at a farther out strike (less extrinsic) to cap our max loss at a reasonable level.

As time goes by, we slowly collect that time premium decay as the extrinsic begins its slow ride to zero. If the stock stays fairly steady, moves with us or even moves slightly against us, we make money. It’s a beautiful thing.

Be sure to ask your TickerTank expert how trading options for income can suit your style. Our options trading system uses this method frequently.

Open a thinkorswim by TDA account today!