Be Wary of Monthly Option Income Needs

This article on your monthly option income needs is Part 3 of a 4 part series on my top option trading tips.

Be Wary of Your Option Income Needs

So what do I mean by being wary about having monthly option income needs? After all, everyone has monthly needs and expenses.

I actually addressed this issue to a degree in a previous article - The Myth of Monthly Cash Flow.

My point in that article was that there are inherent pitfalls in any kind of scenario where you rely on generating - and living off - a set quota of monthly option income (unless, of course, that quota is substantially less than what your trading or investment account generates on average).

As I pointed out then - and still maintain here - the stock market does not behave so predictably as to guarantee a consistent amount of returns each and every month.

Here's another way of looking at it - If consistency and frequency are most important to you, then you're likely going to have to settle for smaller returns.

And if larger returns are most important to you, then you're going to have to get rid of the annuity or paycheck mindset and allow those larger returns to arrive on their schedule rather than yours.

Bonus Psychobabble

I'll also throw out this little psychological nugget - the more you "need" something to happen, the more elusive it seems to become.

The trick then is to approach your option trading from the same place you do in other successful areas of your life - which is from a place of healthy and unapologetic desire and expectation rather than a place of stressed out neediness.

The Ideal Approach to Monthly Option Income

To me the ideal use of the income produced from your option selling operations is no different from any trading or investment returns.

Ideally, you'll just keep compounding everything you make.

Not only will that really snowball your wealth, but you won't lose any sleep either about having draw downs on your account (i.e. withdrawing more from your account than it generates in positive returns).

And you won't start feeling pressure to begin assuming more risk than you should trying to make up the difference.

But, of course, sooner or later, you are going to be living in part or in whole from your investments, right? I mean, what's the point of investing after all?

My point here is that the longer you can delay that reality, the larger (and hopefully more powerful) your holdings and capital will become - and the less strain you'll be putting on those resources.

What you want in the meantime then is a manageable process . . .

A Manageable Use of Monthly Option Income

Again, the less you "need", the better off you'll be on multiple levels.

When it comes to living off the proceeds of your option income, I would encourage you to consider a couple of different possible approaches:

#1 - Percentage Withdrawal

With this approach, you treat your option trading like a business and adopt a policy of only withdrawing a certain percentage of your booked option income for your personal use.

Think of those withdrawals as personal dividends, and do what high quality dividend growing companies do. They usually keep their dividend payouts within a certain payout ratio range (which may differ by company and sector) and retain or reinvest the rest.

You can do the same thing.

And the smaller your own personal dividend payout ratio is, the more room there is to allow your personal dividend to grow in the future, and the more your total capital will increase (which means the more you set yourself up for increased option income going forward).

#2 - Set Amount Withdrawal

Once you've been selling options for a while, you'll probably have a pretty good idea what your longer term average monthly returns are.

This approach is similar to #1 above in terms of the concept of withdrawing less than what you generate, but the actual monthly distribution is calculated a little differently.

Instead of adhering to a specific payout ratio, you simply decide upon a set amount to withdraw each month. But it's important that the set amount to decide upon is substantially below your longer term monthly average return.

Again, this is all about sustainability and continued growth - both of capital and, as a result, future income.

The Monthly Option Income Worst Case Scenario

The worst cast scenario with using monthly option income to pay for some or all current living expenses is when you withdraw a monthly amount that's unsustainable and puts too much strain on your trading or investing account.

If you essentially spend everything you make in the good months, not only will your capital fail to increase or even keep up with inflation, but what happens if you have a flat or even down month?

It's just a matter of time before your capital begins to contract, and with it your standard of living.

Your trading capital (or long term income producing investments) is like a horse carrying you across some pretty rough terrain. Take care of your steed! Make sure he gets water and oats, and don't ride him half to death.

But you "need" a certain amount every month?

Here's my tough love message:

If your option income can't comfortably supply those needs, you're going to have to be realistic and make some choices (either hard or creative) and find alternative funding sources and/or reduce personal expenses or obligations.

Tweet

Follow @LeveragedInvest

Download for Free