How I Made $40K Trading Options on Robinhood
1. Introduction
I began my journey into options trading on Robinhood in May 2018, and by January 2023, I had amassed nearly $40,000 in earnings. If you’re not familiar with Robinhood, it’s essentially a financial app that opens a gateway to investing in stocks, options, ETFs, and cryptocurrencies. What sets Robinhood apart is its user-friendly interface, making it a go-to choice for new traders like myself, drawn by the lower entry barriers into stock trading. However, Robinhood has also gained notoriety for its role in meme stock trading.
Let’s turn our attention to January 2021, when GameStop’s stock was hovering around a modest $17. By February of the same year, that $17 had skyrocketed to over $300, all thanks to the wallstreetbets subreddit community. This online forum is a hub for individuals sharing their high-risk investment strategies and profits, many of whom conduct their trades through Robinhood. This astounding surge in GameStop’s value was the result of a short squeeze, delivering devastating blows to hedge funds and short sellers while changing the fortunes of early investors. As I delved deeper into day trading, I realized that events like these, along with market fluctuations, presented golden opportunities for strategic trading positions.
2. My Initial Trading Strategy
When I set out on my stock and options trading journey, I was as green as they come, much like the majority of beginners. My expertise was limited to the simple buy-low, sell-high mantra. As for options, I grasped that the stock price had to surpass the option’s strike price by the expiration date; otherwise, the option would be rendered worthless.
The initial strategy that I devised was to sell my options when my unrealized profit or loss reached between 10% to 30% of my original cost. For example, if I bought a $130 strike price AAPL call option expiring in one month for $1,000, I would sell it when the call option is priced between $1,100 to $1,300. In the first six months of trading options, I experienced both wins and losses with this strategy. Fortunately, I came out net positive and made an overall profit of $15! Now I will be first to admit that this is far from impressive but considering most traders lose 80% or more of their money over the course of a year, I would consider my small profit a win. More importantly, I learned that trading options involved other variables and risk factors as opposed to looking only at stock prices moving up or down. The valuable lessons I’ve come to learn and understand eventually led me to my profitable journey.
3. The Basics: What are options?
Options are essentially contracts that give the buyer the right to buy or sell the underlying security (typically stocks) at the strike price on or before a specified date. The two main types of options are call options and put options.
Call Option – gives the holder the right, but not the obligation, to buy the underlying security at the strike price on or before the expiration date.
Put Option – gives the holder the right, but not the obligation, to sell the underlying security at the strike price on or before the expiration date.
The option’s price is influenced by many different factors such as movement in the stock price and changes in premium from time decay and implied volatility. The four main types of Greek risk measurements for options are theta, delta, gamma, and vega.
Theta – measures the time decay of an option. The rate of decline in the option’s value increases as the time moves closer to the expiration date.
Delta – measures the change in the option’s price given a $1 move up or down in the stock price. The delta value ranges from -1 to +1 with call options ranging between 0 and 1 and put options ranging between 0 and -1. For example, a call option with delta of .50 will increase the option price by $.50 per share if the stock price increases by $1 per share.
Gamma – measures the rate of change in the option’s delta given a $1 move up or down in the stock price. A higher gamma indicates a greater change in the delta for every $1 move. This means that the option’s price can change dramatically from sudden increases or decreases in the stock price. Gamma typically increases as time moves closer to the expiration date and helps determine if the option will be in-the-money or out-the-money at expiration date.
Vega – measures the rate of change in the option’s price based on a 1% change in implied volatility (IV). Volatility is determined by expected changes in price, historical and future events such as quarterly earnings, and other external events. A greater vega means that the option’s price will be more sensitive from a change in implied volatility.
4. My Current Trading Strategy
INFO: If you have an account balance less than $25K and buy and sell the same security within the same day, it will count as a day trade.
INFO: If you make more than 3-day trades within 5 business days, you will be flagged as a pattern day trader and restricted from day trading for 90 days.
To avoid this restriction, I keep my account balance between $25K to $30K. However, you don’t really need to have a $25K in your account balance in order to trade effectively. From my experience, having between $5K to $10K is enough to trade without worrying about a safety net. In fact, I rarely hold positions over $5K.
I would say that my risk tolerance has decreased as I grew a little older. Just a few years ago, I would trade SPY options expiring in one week and bet on price movements during quarterly earnings. The potential for gains was much higher but so was the risk of the trade turning against you. Furthermore, I would have to constantly follow the stock chart which was extremely draining and stressful.
Nowadays I mostly swing trade long-dated out-of-the-money options, usually with expiration dates 3 months out. The premiums are much higher than with short-dated options, but long-dated options give you more time for the stock price to move in your favor. Additionally, the rate of time decay is much slower on long-dated options.
4A. How do I choose which options to trade?
I mostly hold call options to have as my main position and hold put options as a hedge. The reason is if you look at the historical stock market prices, you will see that the prices naturally move upwards due to inflation and other economic factors. Of course, if you look at smaller time frames, there are periods of economic downturn like during a recession. It is important to analyze the market trend overall as well as at the micro level.
When it comes to trading options, I’ve created a set of rules and strategy that I follow:
- Find companies that I truly believe will be or continue to be sustainable and profitable in the future.
- Wait for the stock or overall market to have consecutive down days. I prefer to see at least 3 consecutive down days. One of my rules is to never chase stocks that have had rapid price increases. I have made this mistake in the past with fear of missing out (FOMO) and it usually doesn’t turn out well.
- Buy out-of-the-money call options with expiration date of 2 months or longer.
- Buy SPY put options as a hedge if you want to be on the safe side. I usually like to have a 3-to-1 call options to SPY put options ratio.
- If stock price continues to go down, I would add to my position to lower my cost average. Otherwise, if I hedged with put options, I could sell them in order to play both sides of the market.
- I make a judgement call on whether I believe the stock price will continue to go up or down. I will either sell at a profit/loss or let it ride out a little longer depending on the time it has to the expiration date. I normally never try to let my options get close to the expiration date because that is when time decay will start to increase rapidly. My other rule is to never get greedy. It is better to sell early with a small profit rather than to sell later with a loss because of greed.
5. Conclusion
My strategy may not work for everyone, but it certainly has worked for me thus far. As of January 2023, I have made almost $40K in net profit within the 5-year period I have been trading. It might not seem like a lot of money, but considering I took a year off within this period and also gained invaluable experience, I really can’t complain about earning this money as a side income.
The important thing to take away is that most profitable traders rely on trading strategies and abide by a set of trading rules. Having good intuition is also important, but traders without a plan become susceptible to trading emotionally or irrationally which usually results in the trader becoming another statistic.
