A few days ago, I heard about a risk-free option trading strategy. There was actually a post in our community about it. One of our members posted a few examples and there was a lot of interest.
This is why I thought I should look into these so-called risk-free options strategies. If such a strategy actually exists, this would be awesome. Let’s take a look.
As I was researching these strategies, I came across a video from this good-looking guy Chris. He has a channel called Project Finance on Youtube. I really enjoy watching his videos.
This is a video from December 15th of last year, so only a few weeks ago. In the video, he explains how to create risk-free option positions. I decided to look into this to see what exactly is he doing here.
Risk-Free Options Strategy
What is the idea of this strategy? I watched the video and I looked into what Chris said as well as what was shared in our private community.
And the idea is to buy a call on a stock that you believe will go up. Nothing special about this.
Then the next part is, a few days or weeks later, sell a call with a higher strike price for a credit. I thought this was quite interesting.
The result is that when you’re selling the call with a higher strike price for a credit, you have a risk-free trade and can’t lose. Is this really possible?
I studied the example from Chris from Project Option, which again, is a great channel. Here is the example that he gave.
On September 23rd, Chris bought the 900 Tesla call expiring January 2023 (850 DTE!). You might be asking yourself, “Is it the 900 Tesla call from September 23rd, 2020?”
Yes, from 2020. Let’s take a look at the charts.
This is a Tesla daily chart, and I removed the 50-day moving average since we don’t need it for Chris’s example from September 23rd, 2020.
He entered the trade right here, when Tesla was trading at around $380, and he said that he bought a call with 850 days until expiration for $101.30.
A few weeks later, on January 8th, Chris sold the 1,500 Tesla call, expiring January 2023 for $233.
As you can see, Tesla then after going sideways for a while, did what Chris wanted it to do. It went up, and Chris timed it perfectly.
He even said in his video, he got a little bit lucky here, selling the call when he did.
Let’s do the math on this. He paid $10,130 for the long 900 call, collected $23,300, and the result is $13,170. Then he said he couldn’t lose and there was only potential to the upside. I thought this was really cool.
This is where one of our members in our private community, Kevin, said he did two trades, according to these rules. I want to dissect these trades and tell you what I think. Here is Kevin’s trade:
On December 20th, 2021, a few weeks ago, Kevin bought five 180 Apple calls, expiring September 16th, 2022 for $13.45. He had to pay $6,725 total. Let’s take a look at this on a chart.
This is when Kevin bought this call, and he bought the 180 call when Apple was at around $170. This is what you do on a stock that you assume is going up.
What Kevin then did a few days later on December 28 was he sold five 190 Apple calls, expiring September 16th. He received $7,200. So as you can see, this is where it resulted in a credit.
He said in his document, “the net credit was $475. If the stock goes above 119 between now and expiration, I will receive $5000 more.“
He sold a few days later, so he didn’t wait as long as Chris, who waited a few weeks.
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Was It A Risk-Free Trade?
I thought I would plug this into an options calculator and see if this was truly a risk-free trade. Turns out it is!
So if Apple moves lower, there’s break-even at $180. If Apple stays at $180 or below between now and September 16th, he will just receive $475, but can’t lose.
In the best-case scenario, if Apple keeps going higher he can collect 5,000 additional dollars, plus the $475 that he received as a credit. This comes to $5,475 total. That is very good.
Now, I want to dissect this trade. I asked Kevin ahead of time if it was okay to use his example and he agreed.
So first of all, the assumption that Kevin had was wrong. He wouldn’t get $5,000 between now and expiration. He would only get the $5,000 if the stock goes above $190 at expiration.
If, for example, over the next few days, let’s say a month from now (at the time of writing it is January 6th), and go out to February 6th, it now goes to $190.
He’s only getting around $3,000. So this is important to know because there is still some time value in there. Keep this in mind. I’m not saying this is why the trade does not work.
The assumption here is if the stock goes above $190 between now and expiration. This is only true if it goes above $190 BY expiration. The expiration date is about 200 days from now, which is quite a while. Just be aware of this.
You will get approximately $3,000 if the stock moves to $190. As the stock moves higher, you will make more money. $5,388 is the maximum he can get on this trade, but this is at expiration.
Considering Theta (Time Decay)
The other thing that I think is worth considering is Theta, which is time decay.
For the 180 call, the time decay is 3.333 cents per day. This is not a big deal in this case because he waited only eight days until he could add this second leg, so he only lost $0.24.
If Chris waited for 107 days, which he didn’t, he would have paid $3.21 in time value.
Is This Strategy Completely Risk Free?
The third thing to consider is that it was not risk-free. In fact, there’s actually more risk. This is what Chris said in his video (around the 10-minute mark) about the risk involved.
Chris: “So to create a risk-free call spread you can’t do it right out of the gates. You have to first take more risk than a traditional call spread because you first have to buy a call option, which is going to have more risk than buying a call spread since you’re not going to be shorting that higher strike call right out of the gates. And therefore you are going to pay a little bit more for just that one single call option as compared to buying a call spread.”
According to Chris, there’s actually more risk in the beginning, so be aware of this before you add the second leg.
What If The Stock Moves Sideways Instead Of Up?
In the beginning, we are taking on a little bit more risk. You lose premium if the stock goes sideways.
Now, in Kevin’s case, he timed it perfectly. He bought Apple and then a few days later, it went up. That was fantastic. It had a really good move.
Keep in mind that there are some other examples where you might be overall bullish on the stock, but the stock at first is going sideways. Let’s go back to Chris’s example when he was looking at Tesla.
Chris actually bought the call, and for a while, Tesla didn’t do anything. For two months it just went sideways.
While doing this, you are losing every day since you have the time decay that is kicking in, losing the theta. It could turn out that your call option is worth less and less.
Capping The Upside
Keep in mind what Chris said. In the beginning, there is more risk. You are capping the upside.
Let’s go back to the Apple chart and see what happens if the stock goes to 200 by March 6th, which is 2 months from now. Maybe you think that it is very likely over the next two months.
With this particular strategy, if we are looking at 200, you would make around, $3,600. Not bad at all, considering it is risk-free. But let’s actually see what happens if you would not have sold this call.
Initially, you bought the 180 call. So let’s see what happens if you just had the180 call and remove the 190 call.. Do you see this? This means that if you had not sold the call and Apple goes over $200 the next two or three months.
This is when you could make $6,000-$7,000 if it moves here rather quickly. As you can see, if you’re selling the 190 call, you’re kind of capped. You make $3,600 if the stock goes up to 200, but If you only had the 180 call, you could make up to $7,000. Everything has pros and cons.
This is where here you could still lose money, as you can see if you just sold the 180 call.
This is why he sold the second call, to lock in profits, but this caps the upside.
So if you’re super bullish on Apple, you are capping to the upside and probably leaving a lot of money on the table.
The question is, is it really better to lock in profits? I looked it up some historical data.
The 180 call, if Kevin would have sold this call right away, was worth $18.40. If he did this as a one-week trade instead of locking himself in until September, he could have made $2,475.
Does it make sense to sell that call in September, or would it be better to just take $2,475 in a matter of a few days?
When Should You Use This Strategy?
When is this a good strategy? What is it for? When does this strategy make sense?
As Kevin said, it’s probably best for a stock that is going up. But no, it’s actually best when you expect the stock to stay in a range. Here’s why.
Chris actually covers this idea 15 minutes into his video, which you can watch HERE. He talks about trading in and out of the short option, and this is where it gets interesting.
The idea here is that Apple goes higher, right? Right now, for example, Kevin has sold the 190 call, now it goes back down. So this means that right now he can buy back the 190 call for cheaper and can pocket some money.
Now if Apple goes up again, then he would sell the 190 call again, right? You keep the 180 call, but now you play around with the short call. This is what Chris calls “trading in and out” in his video. This is how you could collect extra premium.
In a nutshell, what is this good for? It is great if you think that Apple might stay in a range and might not go above $190. As it goes above this price, you are right now capping your profits compared to just a naked call here.
This is where you could probably use this on Apple, and probably on Tesla. If you would have used it at Tesla while it was in this range, it might have worked.
So the important thing here is, unfortunately, as much as we would like to have a risk-free strategy, there isn’t any way this can happen. In fact, in the beginning, you’re taking on more risk than putting on the call spread right away.
And again, great job to Chris, I really enjoy his videos, if you want to watch the video I referenced in this article you can watch it HERE.