How to treat your trading like a business

I’ve read in many places you should treat your trading like a business, but I really wasn’t sure how to do this until I read a post over at Fullyinformed.com

Teddy, the author of the site, goes into great detail on this topic and I’d highly encourage you to pop over to her site and check it out. Fundamentally, however, it comes down to two things:

cash flow and expenses

I don’t think it gets much more fundamental in business.

The tricky part which requires just a little bit of thinking is applying it to your investments. How do you generate consistent cash flow with your investments? How do you control your expenses?

After you read this post you’ll learn how to answer those questions and how I’ve decided to address them this year. As with all things on this site, we’ll see how my plan pans out at the end of the year, but I have to admit it’s working well so far.

Although generating cash flow is probably the most interesting part of investing or trading options, we’re gonna tackle the easiest, and arguably the most controllable part first, managing expenses.

 

Giving your broker a pink slip

When it comes down to controlling expenses in trading options, we’re talking about brokerage commissions and fees. A quick Google search will reveal a jungle of charts and articles comparing the costs and features on the growing zoo of online brokerage firms.

The site Nerdwallet provides an online brokerage firm filter so you can sift through to find the best broker to meet your needs.

A quick search for options trading of just one trade and one contract a month reveals fees ranging from $5.45 (OptionsHouse) to $126.64 (Tradestation)…yikes!

At Optionshouse, I was paying ~$10 per round trip (sell the option then buy it back) on a trade since I opened an account during a promotional event. This is pretty awesome compared to the other choices out there, however it meant my trades had to move $11 in my favor before I made any profit.

Additionally, when I did my 2015 Annual Report I identified commissions and fees nearly matched my trade losses for the year. This effectively doubled my total loss for the year.

No bueno.

For me, finding a way to reduce those costs fell a close second to trade management as a priority for me to address and fix. Luckily, it was an easy fix.

 

Enter Dough.com

I’ve watched the TastyTrade financial network for about a year and a half now. Actually, it’s almost a weekend ritual for me to fire up the Amazon Firestick on our TV and watch a few episodes on the weekend. Even my kids know who “those trading guys”, Tom and Tony, are.

For those of you who don’t know about TastyTrade, it’s a great resource for learning options trading, but best of all they’ve build an intuitive trading platform called Dough.

Dough is a very different type of trading platform from what you’d see at OptionsHouse or even ThinkorSwim (even though they built that too).

I won’t get into all the bells and whistles Dough has (maybe another time), but the best part is they have a deal with TDAmeritrade/ThinkorSwim which allows you to trade options for $1.50/contract.

That’s freakin’ awesome.

Switching to Dough meant I immediately cut my trading costs 70%. I could now trade, round trip, for $3. Now, instead of waiting for a trade to move $11 in my favor, I only need it to move $4.

Not only does this reduce my costs on trades, it also will likely reduce the time i’m in a trade. That’s a win-win ladies and gentlemen.

 

Not so hidden fees

Beyond commissions, there’s quite a few other fees you’ll need to account for when trading options.

For example, my commissions on ThinkorSwim/Dough are not just a straight $3, but $3.07 for a single lot, round trip trade. The extra $.07 is part of some regulatory fee TDAmeritrade has to pay to the Options Gods.

Another fee you should probably think about when you’re building your trading business is the assignment/exercise fee. You’ll end up paying this fee if an option you sold goes in the money and you hold it until expiration.

For example, if I sold a $3 put on CLF and on expiration day CLF closed at $2.75, i’d be assigned the stock and have to pay TDAmeritrade’s fee of $15.

So, if I turned around the next day and sold a call against those same shares of CLF i’d need to take into account the $15 assignment fee into my break even calculation.

Everything boils down to the fact you need to understand your total cost of doing business in the market. Without an accurate understanding of your commissions, fees and other expenses you’ll end up with inaccurate accounting of your money, and not really know if you’re ahead of the game or behind.

But controlling costs isn’t the only part of running a business. If you’re not bringing money in, you might as well just close up shop.

 

Build a stream not a mountain

When most folks think of retirement they focus on a single figure.

$500,000…$750,000…$1 bazillion or more.

People look at retirement like this because they think, “Oh, I’ll save (enter your favorite retirement calculator’s answer here) and then I’ll slowly whittle away at it over time until I die and leave whatever’s left for my kids to fight over.”

There’s even a rule of thumb called the “4% Rule retirement planners use to ensure their clients don’t whittle away at their mountain too quickly.

People will argue, “my mountain will continue to grow” because I’m still invested in the market. Sure the mountain may continue to grow a little, but since you’ve probably moved everything into bonds or money market accounts it’s probably growing at a lower rate than what you’re pulling out.

And to top it off, you’re still invested in the market and at the whim of market movements to make your mountain grow or shrink.

When I first started my options trading journey a few years ago, I approached it with this mentality. I figured if I wanted to earn $5,000/month from trading options I would need a $300,000 mound of cash to make it happen.

See how it happened? Though the $5,000/month income is my stated goal, in reality I was driving towards building the $300,000 mountain I would need to generate the $5,000/month.

Though I think this is probably a bit nuanced, I think you really need to approach this with a focus on the stream of money you’re creating vice the mountain. This isn’t a new idea and it’s definitely not just my own.

In a July, 2012 issue of Time the article discusses how building and having a guaranteed steady stream of income makes people more happy and confident about their future.

Additionally, Tony Robbins in his book Money: Master the Game (affiliate link), says “Always remember that income is the outcome.”

But, how do you go about building a stream of income that grows?

 

Dividend growth stocks…the gift that keeps on giving

I think I’ve found my answer in dividend growth stocks.

But I don’t only seek out growth here. There are many companies out there with high growth dividends, but uncertain futures. I don’t want a company that’s going to pay me a 12% dividend for a few years and then go belly up.

I’d rather have a company paying me 4-6% for the rest of my life which consistently grows somewhere between 5-10% per year.

I’ll write up a separate post on how I went about choosing the stocks/ETFs I did to start this income stream, but for now you need to note this key takeaway:

My dividend are a small, but steady and growing stream of income I can plan for and count on.

On average my I receive $10.75 in dividends per month, $129 per year. That’s cash I can count on coming into my account and allowing me to continue to trade. That’s enough to cover the commission on 43 trades per year.

And the best part is this small amount of cash, without additional infusions of cash, will continue to grow annually and allow me to cover 2-3 more trades each year.

Are there risks going about generating cash for a “trading business” this way? Of course. But there’s risk everywhere in the market, you can’t escape it. But in this case, with the companies I’ve chosen I think i’ve balanced risk and reward to a level acceptable for me.

 

Wrapping up

It took me WAY too long to come to the conclusion of running my trading like a business. Had I explored the possibility of reducing my expenses last year I could have significantly cut my losses.

Sure, my monthly dividend is so small right now it’s almost laughable. Do I think $10 a month is going to make a difference? Nope.

But I’ve started the small trickle of a stream, which with the help of my options trading should grow quickly and begin to produce monthly results which aren’t so meager.

I’m sure some of you out there have figured this out already. If you’ve invested in dividend paying stocks on your own or through the spoils of options trading I’d love to hear about it. And if you’re already into dividend paying stocks leave a comment down below with your favorite stock and why you picked it…maybe i’ll add it to my list!

Happy trading,

Patrick

Join the discussion 2 Comments

  • Gene Alvin says:

    Hi Patrick, As always I enjoy reading your posts. I’ve been using TOS since I started trading and I use TC2000 for my charts, watchlists and scans. I started using Dough about 6 months ago. As they are linked to TD Ameritrade it makes things quite convenient. I find that I like the Dough platform much better than TOS so I use it when trading options. Recently I stumbled into NADEX and found it to be very interesting also. Trading binaries in forex is a really good way to generate weekly income. I’ve only been papertrading the binaries and binary spreads because it is quite different from trading stocks. At this point I’m on the win side in 4 out of 5 trades per night avg. (I trade from 2am to about 7am daily). I’m going to continue papertrading for about another month before going “live”. Do you have any experience with NADEX or Binary Options. I’d be interested in any feedback.

    • Patrick says:

      Gene,

      I haven’t heard of NADEX and I haven’t traded binaries either. It seems you like it quite a bit. You mention you’ve got a win rate of about 80%. Do you come out ahead? What’s the average size trade you make?

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