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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
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 stocks
www.thebluecollarinvestor.com 2 Three Essential Skills
• Stock or ETF selection • Option selection • Position management
www.thebluecollarinvestor.com 3 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.
www.thebluecollarinvestor.com 4 “Moneyness” Of An Option Relationship of the strike price to the price of the stock
Puts (Stock $/strike $) Calls (Stock $/strike $) • OTM ($32/$30) • OTM ($28/$30)
• ATM ($30/$30) • ATM ($30/$30)
• ITM ($28/$30) • ITM ($32/$30)
www.thebluecollarinvestor.com 5 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
www.thebluecollarinvestor.com 6 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.
www.thebluecollarinvestor.com 7 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.
www.thebluecollarinvestor.com 8 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!
www.thebluecollarinvestor.com 9 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
WWW.THEBLUECOLLARINVESTOR.COM 10 PRLB: 1-Year Chart
WWW.THEBLUECOLLARINVESTOR.COM 11 PRLB: 1-Month Chart
WWW.THEBLUECOLLARINVESTOR.COM 12 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
WWW.THEBLUECOLLARINVESTOR.COM 13 Preview Example For Puts ∙ ∙
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∙ www.thebluecollarinvestor.com 14 PREVIEW SCENARIO I
www.thebluecollarinvestor.com 15 PREVIEW SCENARIO II
• • •
www.thebluecollarinvestor.com 16 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)
www.thebluecollarinvestor.com 17 Premium Stock Screen
www.thebluecollarinvestor.com 18 Premium Watch List
www.thebluecollarinvestor.com 19 Option Selection: “Moneyness” And Expiration (1-month)
www.thebluecollarinvestor.com 20 Covered Call Writing Returns
www.thebluecollarinvestor.com 21 Put-Selling Returns
www.thebluecollarinvestor.com 22 Factors That Influence “Moneyness” Decisions
• Identify our goal • Overall market assessment • Chart technicals • Personal risk tolerance • Calculations meet our initial goals (2-4%/month)
www.thebluecollarinvestor.com 23 “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
www.thebluecollarinvestor.com 24 “Moneyness” For Calls
• OTM- Most aggressive ($28/$30): highest potential returns • ATM- Aggressive: highest initial returns ($30/$30) • ITM- Most conservative ($32/$30)
www.thebluecollarinvestor.com 25 Integrating Both Strategies: PCP Strategy
www.thebluecollarinvestor.com 26 www.thebluecollarinvestor.com 27 www.thebluecollarinvestor.com 28 First Q&A
About 15 minutes
www.thebluecollarinvestor.com 29 WWW.THEBLUECOLLARINVESTOR.COM 30 31 WWW.THEBLUECOLLARINVESTOR.COM 32 WWW.THEBLUECOLLARINVESTOR.COM 33 34 15 minute break
www.thebluecollarinvestor.com 35 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
www.thebluecollarinvestor.com 36 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
www.thebluecollarinvestor.com 37 Disadvantages
• Early exercise may result in tax consequences • Share appreciation is limited by the strike price • Learning curve • Modest time commitment
www.thebluecollarinvestor.com 38 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
www.thebluecollarinvestor.com 39
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
www.thebluecollarinvestor.com 40 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
www.thebluecollarinvestor.com 41 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
www.thebluecollarinvestor.com 42 Ex-Dividend Date For AXP
www.thebluecollarinvestor.com 43 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
www.thebluecollarinvestor.com 44 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
www.thebluecollarinvestor.com 45 Home Depot: Ex-Date
www.thebluecollarinvestor.com 46 Home Depot: 1-Month Options Chain
www.thebluecollarinvestor.com 47 1-Month Returns
• $41/$8044 = 0.51%, about ½%
• Share appreciation potential to $83= • $83 - $80.44/$80.44 = 3.1%
www.thebluecollarinvestor.com 48 Home Depot: 2-Month Options Chain
www.thebluecollarinvestor.com 49 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
www.thebluecollarinvestor.com 50 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 www.thebluecollarinvestor.com 51 Using a Zero-Dollar Collar to Protect Low Cost Basis Stocks
www.thebluecollarinvestor.com 52 www.thebluecollarinvestor.com 53 Summary to Master Option-Selling
• Must master all 3 required skills Stock selection: (fundamental analysis, technical analysis, common sense principles) Option selection: (“moneyness”, expiration date, returns meet goals) Position management: (bullish and bearish scenarios)
www.thebluecollarinvestor.com 54 www.thebluecollarinvestor.com 55 www.thebluecollarinvestor.com 56 www.thebluecollarinvestor.com 57 www.thebluecollarinvestor.com 58 59 www.thebluecollarinvestor.com 60 www.thebluecollarinvestor.com 61 62
Covered Call Writing And Put-Selling
Generate Monthly Cash Flow using Two Conservative Option Strategies
Hosted by: Dr. Alan Ellman President of The Blue Collar Investor Corp.
www.thebluecollarinvestor.com
www.thebluecollarinvestor.com