Options 10/6 rule

While this was printed almost 10 years ago, it is still valid in today’s market. Simply stated, 10 percent away from the current price and 6 months out .

That is it in a nutshell, but to implement this we need to understand a few things. This is the important part. Miss this and you might as well not trade this way.
1) Do not try these on individual stock you will understand the reasoning for this after we talk about rule 2
2) Know where the underlying has been sounds good so far.

What you have here is a high probability trade. If we look to history we see that a normal market in equities rises typically not more than 10% in any given time. So we have run ups and then consolidation.

That is where the sell in May and go away mantra came from. The markets most movements tended to be in the periods from Nov. to April. So year over year while the net for the year is about 8% (yes we are talking more than the gaga years as history) So now that we know what is typical, when we see a market move that far in a short time frame, we have good probability that the market is prone to stall if not go down.

Knowing this we can now go up 10% from the current price and sell a spread. Now we all know that going that far out of the money will not generate enough premium for the credit to make it worth our time. So we go out 6 months to collect enough premium to make it worth out while.

If you did nothing more than sell these spreads every May you would come out with a very good return.

Bear in mind (pun intended) that this works for the down side as well, in other words when we have a market correction of 20%-30% we can have great expectations that the market will rally from here. So a credit strategy 10% below the current price will accomplish the same effect.

If you are looking to enhance a portfolio of conservative investments, you may want to look to an idea like this. It should not take more than 5% of a portfolio to gain the extra 5%-10% gain you are looking for.

This will take some practice and should be tried with a Virtual account. Many of the topics we discuss are not intended to be used solely but are meant to be used to put your portfolio over the top and stay ahead of inflation.

Make sure you feel confident in this by trading virtual before you try it with real money. CBOE.com has a virtual trading platform on their site.