The Myth of Monthly Cash Flow

It's what I call the Myth of Monthly Cash Flow.

Don't get me wrong. I love high yield income.

And one of the reasons I love stock options so much is because there are many different option trading strategies one can employ to generate high yield income. The potential cash return from option trading dwarfs the typical income streams available through more traditional income investments such as bonds and dividend paying stocks.

Option income strategies are not without risk, of course. But, conversely, there's no rule that actually says these trades have to be reckless in order to be lucrative. In fact, just about any option trading strategy that generates a credit can be used to create your own personal cash flow business. And those can be as risky or as conservative as you choose.

As such, the option writer has many choices to consider - covered calls, cash-secured or naked puts, bull put spreads, bear call spreads, and iron condors are all common option trading strategies that can result in great short term cash returns relative to the amount of money placed at risk.

There are numerous online resources that focus on income producing option strategies, some free and some subscription based. Many of these online resources are quite valid and valuable. But in the vast majority of cases, option income strategies are described explicitly as, or touted as great potential candidates for, high yield monthly cash flow vehicles.

So why is that a problem?

If you think about it, isn't it perfectly natural to view covered call writing and various credit spread trading strategies as a means to generate sizable MONTHLY income?

After all, there are two primary factors reinforcing this perspective: every month, a different set of options expire, and, just as importantly, most of our bills and other financial liabilities come due on a monthly basis.

But there's a major problem with the idea of an options based monthly cash flow business.

Only in theory can you consistently produce a steady, predictable stream of income month in and month out. In practice, no market index or individual stock is so predictably well behaved.

If it is, then that index's or stock's implied volatility (and therefore the amount you get when you write its options for income) will be quickly readjusted downward to reflect its newly tamed behavior.

No matter how conservative you are, how lucky you are, how much the odds are in your favor, or which specific income strategy you employ, there's a chance than any credit spread you set up is going to move against you.

To require of yourself or a dynamic stock market returns that are consistent AND high yield AND monthly is unrealistic and serves only to increase the chance that your trades WILL move against you.

Quota Danger

And why is that?

Quite simply, when you approach option income strategies with a quota mindset, or an inflexible requirement that all your trades need to produce a certain percentage return over the course of the next month's option cycle, the quality of your trades will deteriorate.

When good four week opportunities are unavailable on the Monday morning following the previous option cycle's expiration, you will instead be tempted to chase premium and choose an inferior trade. The required four week return can easily take precedence over the quality of the trade and the likelihood of its success.

There's absolutely nothing wrong with attempting to use options to construct a cash flow operation. It isn't the option cash flow that I object to - it's when you tack on the extra stipulation that the cash flow must occur on a regular, set schedule that you begin to sabotage yourself.

Security vs. Freedom

High yield returns and consistent monthly cash flow are opposing mindsets with little chance for reconciliation.

Like much of life, it seems, we must choose between security and freedom. The stock market is a mystical creature of the forest that, if approached properly, can lead you to treasure. But it doesn't always take the same path or travel at the same speed. It is not a dumb brute that you can bridle and beat into domestication.

Domestication is the key here. That's the fantasy of the Monthly Cash Flow mindset. But profits in the form of option income can't be domesticated unless you castrate them first.

If you want lucrative returns from your option income strategies you must lose the Monthly Cash Flow mindset. You can't have both high yield cash returns AND the consistency of a regularly scheduled annuity payment. If you want the security of a specific payout on a specific date, you'll have to ratchet back your expectations of how much those payments will be.

Great income returns are very much possible, but successful income traders are flexible and patient. If you want to earn 60% a year in returns, don't attempt to do so by anticipating a 5% realized payout on the third Friday of each month all year long.

In general, the more frequently you need to be paid in life, the poorer you're going to be. This is as much a cause as an effect. The annual income of a day laborer, for example, may be paltry, but the primary cause of his poverty is that his daily pay structure requires and reinforces a short term mindset.

The more of your income you can produce irregularly and covering longer periods of time, the more consistent and healthy your overall returns become.

Moving from a monthly mindset to a quarterly mindset (or even an annual mindset) is as radically beneficial as the day laborer moving from a daily mindset to a monthly mindset.

So when you send your ships to sea, be flexible and patient, and let them return on their schedule, not yours.

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