There are, broadly speaking, two ways of making money. The first is to exchange your time for money and the second is to exchange your money for money. The first way is to undertake something like a job or to freelance. You’re investing your time into a project and in return you get paid. Yes, you’re really getting paid for a result if you’re freelancing but my point is that it takes time to produce that result.
The more time you spend on such tasks, the more your earning ability is. If you’re a freelance writer, for example, the greater the number of high-quality words you produce, the more you’re going to get paid per month. Thus, one of the important things to note about this sort of income is that when you go to sleep, so does your income stream.
When asked about one of the key things that rich people do that poor people don’t, Bill Gates responded by saying that the rich leverage their time a lot better Bodnar, 2017. What does leverage time mean? Well, Gates’ point was that the only thing that is truly limited in our lives is time. We cannot get back the time we’ve lost, no matter how much we would like to believe that time machines exist.
So ultimately, being financially successful comes down to how well you manage your time. The fact of the matter is that a rich person manages to get paid more for a unit of their time than a poor person does. So how do you get paid more per hour?
Leveraging Time
One easy way is to up skill yourself. Simply learn a higher skill and work in a more lucrative field. However, even this doesn’t fully leverage your time since once you go to sleep, your money tap is switched off. Hence, the thing to do is to create multiple streams of income. If you have two streams of income paying you at the same time, you can double your hourly wage.
The problem is that you can only do so much at once. You can’t perform two jobs at the same moment of time. So, what you really want is another source of income that doesn’t place demands on your time which will detract you from your job or hourly source of money. This is precisely what a passive income stream is.
Passive streams leverage your time by simply providing you with an additional amount of money for no additional input of time. I want to make something clear at this point; you will need to spend time creating and maintaining the passive income stream. My point is that your earning ability with this stream doesn’t directly depend on how many hours you put into it.
If you spend five hours writing, you’re going to get paid for the words you produced in those five hours. If you spend five hours on a passive income stream, you’re not going to get paid for those five hours necessarily. You could get paid less, you could get paid more, who knows? The point is that whatever comes, adds to your income as long as you spend the time to do things correctly.
For example, a savings account provides you with passive income. A real estate investment on which you earn rent provides you with passive income. You can spend ten hours a day maintaining your property or spend two hours, it doesn’t matter. It will earn you the market level of rent as long as things are maintained properly. There is an aspect of marginal utility with passive income, as economists call it Bloomenthal, 2019.
Marginal utility refers to the return you receive, in satisfaction or dollars, for every unit of work spent. So, if you spend five hours fixing the taps, that is probably going to make you good money. Spending an additional hour figuring out which exact shade of white the walls need to be painted with is probably not going to make you much. Hence, the marginal utility of the former is a lot higher than the latter.
All passive income streams have a level of maximum marginal utility before the returns start dropping off. Trading options, if you’re catching on, is subject to the same forces. Remember that your return is measured not just in money but also in the satisfaction and quality of life you receive. So, you need to figure out this value first.
A good way of understanding the value you’ll receive and checking which style of trading you wish to adopt is to understand the styles of trading themselves. This way, you can make an accurate judgment of what suits you best.
Active And Passive Trading
As far as the SEC is concerned, all trading is active. Passive actions are reserved for the investment world. Whatever the good folk of the SEC might think, in reality, there are active forms of trading as well as passive forms. The diversity of the markets means that there exist many ways in which you can divide trading activity. Active versus passive simply happens to be one method of doing so.
Active trading refers to what you think traders actually do. This is where people sit glued to their terminals waiting on tenterhooks for news items to be released and then acting like hotshots when they make money. All of this is accurate except for that last bit which is a caricature. Either way, active trading usually involves taking directional bets on the market and usually hedging that with some other financial instrument.
Institutional traders, the kinds that trade for hedge funds, big banks and proprietary trading firms (prop shops), are all active traders. No matter what sort of strategies they employ and no matter which instruments they trade, they’re always in touch with the markets. They need to be this way because their objective is to squeeze every ounce of money available.
In order to do so, they have to follow the market’s every move. They need to know the market backwards and cannot have things sneak up on them. What’s more, they need to deal with unexpected things that happen over holidays or weekends. For example, as of this writing, oil traders around the world have had to deal with the repercussions of a couple of Saudi Arabian oil fields being attacked.
This happened over the weekend and when the markets were closed. As they returned to work on Monday, you can bet that none of them had slept through the weekend. Active traders tend to look at this sort of thing as an opportunity. Market mispricing happen during such events and opportunities present themselves. One needs to love the adrenaline rush that occurs during such times. It’s no surprise then, that at big banks, the average trader spends about five years on a desk before moving onto a managerial position where they supervise other traders who ultimately place all the bets.
It just isn’t easy keeping up with such a lifestyle, after all. In contrast to this active trader, we have the passive trader. The passive trader’s returns are not comparable to the active ones. This doesn’t mean they make less money, just that they make less than the average active trader.
The tradeoff is that they get to spend their time doing something else. Understandably, a lot of big banks look down upon this sort of thing since a good quality of life on the trading desk usually means losses. However, some hedge funds and other private institutions welcome this sort of thing actively.
You see, a holy grail in the financial world is the pursuit of market neutral returns. Market neutral means that the strategy makes money no matter what the market does. In such strategies, a trader sets things up via complex financial instruments and then lets the market play itself out. This doesn’t mean they go to sleep after this, they simply recycle the strategy in as many markets as possible.
Thus, while the strategy is passive the trader is active by choice in such institutions. There are sole traders who fix their level of activity within prop shops by trading this way. There is a lot of freedom in such strategies since the trader is not chained to their desk out of necessity. They can vary their involvement in the market and while the returns don’t compare to active strategies, the overall payoff is worth it to the trader.
Almost every passive strategy involves the use of options. The ones that don’t involve the usage of derivatives that behave like options.
Pros and Cons of Passive Income
While there seem to be a lot of positives from passive income, I must warn you that it isn’t all a bed of roses. Even roses have thorns, after all. The negatives that lend themselves to passive income almost entirely have to do with how people approach it. A lot of people think that this is lazy money and that things run on autopilot.
Well, this is not the case at all. Every passive income stream, including the ones to do with trading require investment of either time or money or both. In the case of passive trading income, you need to invest both. Time is needed to learn and study the markets and to develop your skills.
The markets are not easily deciphered mainly because they are chaotic. Our brains are designed to handle linear environments and understand step by step patterns easily. However, patterns that present themselves intermittently, rhyming with one another instead of replicating themselves exactly, are an alien language.
Thankfully, our brains are learning machines and over time, we can learn to spot such patterns. This is really what trading is all about. Time is needed to train your brain to get used to this new world where everything happens at random but plays out according to a perfectly predictable bigger picture.
Therefore, you need to spend time learning the markets and understanding the INS and outs of options. You need to learn their characteristics to such an extent that you should instantly be able to decide whether to adjust a trade or not. Options trades are complex on the surface since they involve at least two legs. Adjustment is a case of removing both legs and just one and establishing another leg elsewhere.
This calls for mental agility, so you need to spend time to work up to this level. Do not expect to be able to do this overnight. The other thing to invest into this is money. This is simple enough to understand. You need money to trade and as mentioned earlier, your level of capitalization is going to determine how long you can survive.
This sounds like a bleak thing to say but it’s better to assume the worst in these situations in order to set yourself up for long term success. This way, there’s no chance you’ll ever take this endeavor lightly. Now that I’ve addressed the negatives, let’s look at the positives.
Simply put, passive income can make you money while you sleep. It also frees up your time to do more things since you’ll eventually reach a stage where your passive income exceeds your active income. This gives you the option to quit your job and do something else with your time. At this point, most people decide to set up another source of passive income which further leverages their time.