Steady Income
There are many different ways to earn a steady income every month, but how many are fun flexible and reliable?  I use two types of income spreads to regularly achieve this steady cash flow.  In the article below I am assuming that you have more than just the basic understanding of trading stock options. This is not meant to be a course on trading options.

Anyone who has traded stock options for any length of time is all too familiar with the affects of time on the premium of an options.  As a buyer of options, time is against you.  You have to be very good or very lucky to have a stock move in the correct direction right from the moment you buy a CALL or PUT option.  Since luck has no place in trading options, that leaves being very good.  Even the best traders are quite often wrong, what makes them good is their ability to cut losses quickly and protect their principle. 

However, when you are the seller of an option time suddenly becomes your friend.  You want the stock price to stay in a narrow range and for time to pass quickly.  The odds tend to favor you when you are a seller of an option.  Why?   I will first briefly cover the two strategies I use on a regular basis:

BULL-PUT SPREAD
When I think the general direction of a stock is up and expect it to stay steady or climb up in the next few weeks, I use the Bull-Put spread strategy.  In this strategy I sell a PUT option that is out of the money and buy a PUT that has a strike price bellow the one I sold.  Let me give you an example excluding commissions:

Example:
Stock: ABC
Price: $81.50
Date: March 01, 2007
Sell: ABC March 75 PUT - I receive $1.55 (hypothetical price)
Buy: ABC March 70 PUT - I pay out $0.95 (hypothetical price)
Gross Income: $0.60

In this example I think that ABC will remain above $75.00 and close above this price on March 16, 2007.  The difference between the sell price and buy price is $0.60 credit.  The amount at risk for this trade is $4.40 (5.00-0.60).  The first thing my broker will do is lock up $500.00 within my account.  Since I will receive $0.60 or $60.00 ($0.60x100), I will need to have $440.00 plus commission in my account.  This $500.00 goes towards settling this position if I am 100% wrong on this trade.  Say at expiration ABC is $69.00.  I will then have to buy ABC shares from someone at $75 and I will then turn around and sell them for $70.00. 

However, if I am right and ABC is at or above $75 at expiration, both legs of the spread are worthless and I get to keep my $60.00 ($0.60x100 shares).  This represent a 13.64% (0.60/4.40) return on my risk money.  That is a good return for 3 weeks or less.

BEAR-CALL SPREAD
If I think the general direction of ABC stock is down and expect it to stay below $85 for the next few weeks,  I use the Bear-Call spread strategy.  In this strategy I will sell a CALL option that is out of the money and buy a CALL option that has a strike price above the one I sold.  Let me give you an example:

Example:
Stock: ABC
Price: $81.50
Date: March 01, 2007
Sell: ABC March 85 CALL - I receive $1.55
Buy: ABC March 90 PUT - I pay out $0.95

The logic is similar to the above example but in the reverse.  I need ABC to remain and close below $85 on options expiration.  That would make my spread worthless and I would get to keep my income of $60.00.  In both the examples I am making $0.60 while risking $4.40.

How Much Money Do I Need
I would suggest you consider having a minimum of $20,000 dedicated to trading income spreads.  So if you take a spread and earn say $0.45 on a 5 point spread your return is around $1,935.00 minus commissions.  This assumes you buy and sell 43 contracts.

Can I Lose Money Trading Option Spreads?
Like most things in life there is no certainties.  So yes the possibility of loss always exists with every single trading position I take.  I do several things to make sure the odds are in my favor.  The most important ones being:

1. Greed Management
   After years of trading I have become good at managing my greed.  I tend to take conservative spread positions.  I chose a strike price that is not too close to the current stock price.  I earn a little less but the odds start favoring me.  The temptation to take a spread where you can earn above 13-15% is high, resist it!
2. Set A Cut Loss Price
   I never enter any position without having clear exit points for my trade.  If you are unable to set a cut loss price, then do not trade.  I do my best to not let my pride and ego force me to hold on to a losing position too long which is a sure way to end your trading career before you have time to learn and master the finer points.
3. Unsure of Stock Price Trend
   If for some reason I am suddenly not sure which way the underlying stock is going to move, I close my spread position.  More often than not I make a small profit, because with the passing of time the premium has eroded.  Uncertainty is often a precursor to loss.
4. Time To Expiration
   I usually take spread positions about 15 trading days before expiration.  Sometimes a few more days and sometimes less.  There is a fine balance between time left to expiration and time premium left in an option.  In my experience 3 weeks prior to expiration meets my criteria.  If there is too much time left the odds of being unpleasantly surprised are high.

How Do I Pick The Right Stock Option?
A very important step in all of this is picking the right stock option to trade.  You have to know how a stock tends to trade and the current trend in place.  This comes from following a few select stocks.  Knowing how to read stock charts is also compulsory.

You might be thinking of trading a safe and non-volatile stock option.  Let me inform you that the options market is very sophisticated and is several steps ahead of you and I.  It is hard to make any money on stocks that do not move much in price.  The market knows that and prices the options accordingly.  The "No risk no reward" theory is an integral part of the Options Market.

Some Statistics
I have put together a simple spread sheet to illustrate the power of making between 7.5-10% a month for 2 years, while reinvesting the earnings every month.

In the above table I start with $20,000 principle and reinvest the gains.  In this case I go with the best case scenario of a 10% return every month.  I end up with a gross profit of $196,694.12.  Not too bad I would say.  Now let us look at the same data using 7.5% return every month.

The numbers still look good.  A 7.5% return every month is safer but over time gives me a return I can live with.  I always assume that there will be some losses along the way.  Therefore a 7.5% return is more realistic and can be achieved with care and some hard work.

What Is My Secret?
I cannot give it all away.  This is where I shamelessly push my Option Basic course and Advanced Strategies lessons.  I would suggest you consider subscribing to my weekly Options Trading Newsletter.  I take 1 to 2 option spread positions every month.  Please join me and hopefully you found this article useful and insightful.