Last week I wrote about a new Netflix documentary in Anatomy of the GameStop Saga. In a nutshell, I wrote about the money that was made and lost as meme traders bid up the share price of GameStop (NYSE: GME), which ultimately came crashing back down.

In that article, I also discussed how I made a low risk bet on the volatility of GameStop’s share price. I sometimes refer to this strategy as “money for nothing” or “printing money”, because it’s literally conjuring money from thin air.

Low-Risk Option Trading

In times of extreme volatility, sometimes you will see option values that become grossly inflated. Money can be made in times like this.

Let’s review some basic terminology.

An option gives the buyer the right, but not the obligation, to buy or sell shares at a defined price and on or before a defined time. An investor can buy or sell options.

The option contract defines the price at which the trade would be executed (the strike price), the date by which the trade would occur (the expiration date), and the premium (the cost) of that option.

There are two types of options: calls and puts. A call is a contract to purchase shares at a defined price and a put is a contract to sell shares at a defined price.

A person buying the put may be buying insurance against losses in the share price of the stock.

For example, if you owned GameStop as it soared from $20 a share to more than $400 a share, you might want to see how high it might go, while buying “insurance” against a total price collapse. In that case, you could buy a put option.

If you wanted to be able to sell your shares for at least $300, you could have bought a put with a strike price of $300, while hoping it climbed higher. But, in case of a collapse back below $300, you would still receive $300.

In normal circumstances, the “insurance premium”, or put is only going to cost a few percent of the value of the shares; maybe 3-5%. But an opportunity arises when a stock becomes highly volatile. Then, the premium prices skyrocket.

That’s when you want to step in as a seller. Let me walk you through this opportunistic trade.

My criteria for put trades is that I try to achieve annualized returns of at least 10% while taking minimal risks. Note that while you are earning these returns, you have cash set aside to cover the possibility of assignment. More on that below. But the important thing is that you are earning interest on this cash you set aside (currently about 5% in a brokerage money market account). So, total annualized returns for selling these puts are at least 15% at low risk.

When you sell a put, you are accepting a condition. If the share price is below the strike price at expiration, you will have to buy shares at that price. (Assignment can also take place early if shares dip below the strike price).

With GameStop at $300, I sold a put with a $17 strike price. For that, I received $6.50 a share. Option contracts are in 100 share increments, so I received $650 for each contract I traded. If assigned, I would have to buy $1,700 of GameStop shares, but that would be offset by the $650 I had received.

In order for me to be assigned, the share price would have to fall by ~95%. You can use free option probability calculators to estimate the chances of this happening. Ultimately, on this low-risk trade I made 23.5% in under six weeks, or more than 200% annualized.

Valero Case Study

I have talked enough about GameStop. Let me walk you through a trade I recently closed in my Income Accelerator publication. The GameStop situation was unique because of the extreme volatility, but the next trade is relatively common.

In June, I identified the oil refiner Valero (NYSE: VLO) as having a good risk/reward balance. It also passed my five rigorous screening metrics. With shares trading at ~$110, I recommended a put with a $95 strike price, expiring in December of this year. The put premium we received for this trade was $5.60 a share, or $560.

WATCH THIS VIDEO: The “FUD” Factor: Overcoming Fear, Uncertainty and Doubt

The risk we were accepting was having to pay $95 a share for 100 shares of Valero (total outlay of $9500 minus $560 because of the put premium we received). The annualized return we would receive on this put was 11.1% (plus the 5% in interest) with a calculated assignment risk of just 26%.

From there, Valero shares went on a run, rising to nearly $140 a share by early August. When that happens, the share price is getting further from the strike price, and the value of the put declines. So, when the value of the put fell to only $0.60 a few weeks ago, we bought it back.

On the money we “risked” we earned $5.00 a share in 83 days. That’s 27.4% annualized on a trade that had a mere 26% chance of assignment. “Losing” on this trade meant buying a great company for $95 a share, when it was $110 at the time we set up the trade.

To be clear, the worst-case scenario here would be if Valero shares collapsed by expiration. Perhaps we had to pay $95 a share for something that might only be trading for $80 a share at that time. But there are two things to keep in mind. In this case, we would have offset our cost basis by $5.60 a share, and we would have ultimately gotten shares at a discount of nearly 20% from the day we set up the trade.

Second, there is another strategy you could use if the trade isn’t going your way. You can always “roll” the position to a future date, while waiting for the share price to recover. This involves buying back the put you sold, and selling another, further in the future for hopefully another premium.

I have said many times that this trade is like getting money for nothing. There is a risk, but you can keep the odds in your favor. It’s a very conservative option strategy that you can use for money that is idle in your brokerage account.

Editor’s Note: If you’re looking for ways to generate steady income, regardless of the market’s ups and downs, consider my colleague Robert Rapier.

Robert Rapier is chief investment strategist of our premium advisory, Utility Forecaster. No one understands dividend-paying stocks better than Robert.

After painstaking research, Robert found a rare type of investment that has raised its payouts by double-digits every year for the past 16 years. If you’re tired of anemic payouts, Robert has the remedy. Click here for details.

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