at a discount using two low-risk option strategies how to ...2016-07-16)ellman.pdf · •sell otm...

How To Generate Monthly Cash Flow And Purchase Stocks At A Discount Using Two Low-Risk Option Strategies

Covered Call Writing and Selling Cash-Secured Puts

Hosted by:Dr. Alan Ellman

President of The Blue Collar Investor Corp.

www.thebluecollarinvestor.com

[email protected]


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http://www.thebluecollarinvestor.com/


Strategy Overview

• Sell call and put options to generate monthly cash flow

• Sell OTM puts to buy stocks “at a discount”

• Sell OTM call options to enhance returns for a buy-and-hold portfolio

• Use both covered call writing and put-selling to develop a multi-tiered option selling strategy

• Zero-dollar collar to protect low cost basis stockswww.thebluecollarinvestor.com 2

Three Essential Skills

• Stock or ETF selection

• Option selection

• Position management

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Definitions

■Call option- Gives the holder the right, but not the obligation to buy 100 shares of stock at a fixed price by a specified date. Call options will be used in the PCP (put-call-put) strategy

■Option- A contract that gives the holder the right, but not the obligation, to buy or sell 100 shares of stock at a fixed price (called the strike price) by a specified date (called the expiration date). It is the right to execute a stock transaction.

■Put option- Gives the holder the right, but not the obligation to sell 100 shares of stock at a fixed price by a specified date.


“Moneyness” Of An OptionRelationship of the strike price to the price of the stock

Puts (Stock $/strike $)

• OTM ($32/$30)

• ATM ($30/$30)

• ITM ($28/$30)

Calls (Stock $/strike $)

• OTM ($28/$30)

• ATM ($30/$30)

• ITM ($32/$30)


Option Premiums In Relation To Stock Price

• Premium = intrinsic value + time value

• Intrinsic value = amount ITM (only for ITM strikes)

• Time value: Total premium – intrinsic value

• All premiums consist of time value only for ATM and OTM strikes


Preview Example For Calls

• Purchase 100 shares of Company XYX @ $48 per share = $4800.

• Sell an option: sell someone the right to buy these shares for $50 per share during the next month.

• You are paid a premium of $1.50 per share = $150.• This is a 3.1% 1-month return = 37% annualized.


PREVIEW SCENARIO I

• At the end of the month, the stock price is less than $50; your shares are NOT purchased.

• You keep your 3.1% 1-month profit and are free to sell another option.


PREVIEW SCENARIO II

• At the end of the month, the stock price is above $50 per share and your shares ARE purchased.

• You now make an ADDITIONAL $200 on the sale of the stock.

• Total 1-month profit is $350 = 7.3% 1-month return = 87% annualized!


Real Life Trade With PRLB

• 9/23/13: Buy 100 x $78.10

• Sell 1 x October $80 @ $3.30 = initial 1-month return of 4.2%

• 10/8/13: BTC $80 call @ $0.45 (slightly above the 10% guideline)

• 10/14/13: STO $80 call @ $1.40 (“hitting a double”) for an additional $95/contract credit

• 10/18/13: Allow assignment as stock is trading above $80 and there was an upcoming earnings report on 10/31/13

• 10/19/13: Shares are sold for $80 for an additional $190 per contract (bought @ $78.10)

• Total profit = $330 + $95 + $190 = $615 = 7.9%, 1-month return

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PRLB: 1-Year Chart


PRLB: 1-Month Chart


Summary Of Principles, Rules And Guidelines Used

• Stock selection using fundamental and technical analysis as well as common sense principles

• Option selection based on market assessment, chart technical and risk tolerance

• Exit strategy execution using 20/10% guidelines

• Expiration Friday decision based on earnings report rule


Preview Example For Puts∙∙

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PREVIEW SCENARIO I


PREVIEW SCENARIO II

•••


3-Pronged Approach To Creating A High-Quality Watch List

• Fundamental Analysis: Earnings and revenues

• Technical analysis: Reading a price chart

• Common sense principles (diversification)


Premium Stock Screen


Premium Watch List


Option Selection: “Moneyness” And Expiration (1-month)


Covered Call Writing Returns


Put-Selling Returns


Factors That Influence “Moneyness” Decisions

• Identify our goal

• Overall market assessment

• Chart technicals

• Personal risk tolerance

• Calculations meet our initial goals (2-4%/month)


“Moneyness” For Puts

• First establish goal (income only, buy @ discount, use with ccw)

• *OTM- Most conservative ($32/$30)

• ATM- More aggressive ($30/$30)

• ITM- Most aggressive ($28/$30): exercise most likely


“Moneyness” For Calls

• OTM- Most aggressive ($28/$30): highest potential returns

• ATM- Aggressive: highest initial returns ($30/$30)

• ITM- Most conservative ($32/$30)


Integrating Both Strategies: PCP Strategy


First Q&A

About 15 minutes


15 minute break


Portfolio Overwriting

• Enhance the returns of a buy-and-hold strategy

• To increase by 6% per year, our goal is ½% per month

• Use out-of-the-money strikes to allow for share appreciation


Advantages

• Generate a constant, guaranteed monthly cash flow

• Downside protection in bearish markets

• Most retail investors are granted this level of trading approval

• Can be used as an additional monthly source of income


Disadvantages

• Early exercise may result in tax consequences

• Share appreciation is limited by the strike price

• Learning curve

• Modest time commitment


Why Is Early Exercise So Rare?

• Call buyer can keep cash in an interest-bearing account until the last minute

• Call buyer exposed to greater risk because stock price > option price

• Loss of time value of option- call buyer makes more money selling the option


What If Stock price > Strike Price By Expiration Friday?

• Easy to avoid exercise and sale of shares

• Roll the option: buy back current month option and sell the next month option prior to 4PM EST

• Roll out- same strike

• Roll out and up- higher strike


Early Exercise And Dividend Distribution

• Ex-dividend date close to expiration Friday

• Call strike is in-the-money (lower than stock price)

• The dividend is > time value of the option


How To Avoid Early Exercise

• Access ex-dividend dates

• www.dividendinvestor.com

• Sell option the day after the ex-date

• Sell a 2-month option


http://www.dividendinvestor.com/

http://www.dividendinvestor.com/

Ex-Dividend Date For AXP


Guidelines For Avoiding Early Exercise

• If the ex-date is in the 1st week of a contract, sell the option the next day

• If the ex-date is later in the contract, sell a 2-month option after expiration of the previous contract


Assumptions For Practical Application

• Long-term buy-and-hold portfolio with shares at a low cost basis

• Goals to generate higher returns and avoid exercise

• Roll options if strike is ITM by expiration

• Sell options the day after the ex-dates in the 1st week of a contract

• Sell 2-month options if later in contract

• Our goal is an additional 6% per year


Home Depot: Ex-Date


Home Depot: 1-Month Options Chain


1-Month Returns

• $41/$8044 = 0.51%, about ½%

• Share appreciation potential to $83=

• $83 - $80.44/$80.44 = 3.1%


Home Depot: 2-Month Options Chain


2-Month Returns

• Goal is now 1% to annualize to 6%

• Goal is about $0.80

• Choices include the $82.50 strike @ $1.06 and the $85 strike @ $0.44

• With multiple contracts use 1/2 of each to average to 1%

• If a single contract favor the lower goal for less need to roll the option


Summary

• Portfolio overwriting is a low-risk way of enhancing portfolio value

• In non-sheltered accounts, avoiding exercise is important if the cost basis is low

• Dividend distribution is the main reason for early exercise

• Covered call writing limits share appreciation to the strike


Using a Zero-Dollar Collar to Protect Low Cost Basis Stocks


Summary to Master Option-Selling

• Must master all 3 required skillsStock selection: (fundamental analysis, technical analysis,

common sense principles)Option selection: (“moneyness”, expiration date, returns

meet goals)Position management: (bullish and bearish scenarios)


Covered Call Writing And Put-SellingGenerate Monthly Cash Flow using Two Conservative Option Strategies

Hosted by:Dr. Alan Ellman

President of The Blue Collar Investor Corp.


[email protected]


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at a discount using two low-risk option strategies how to ...2016-07-16)ellman.pdf · •sell otm...

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