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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
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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
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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.
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“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)
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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
– Stock $56
– Strike $50
– Premium $8
– IV $6
– TV $2
• All premiums consist of time value only for ATM and OTM strikes
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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.
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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.
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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!
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Preview Example For Puts• Stock BCI is trading @ $75
• The out-of-the-money $72.50 put is selling for $2 for a 1-month
expiration
• We deposit $7,050.00 into our cash brokerage accounts per 100
shares of obligation
• We sell the put option for $200 per 100 shares of obligation
• This option premium is ours to keep no matter what transpires by
the end of the contract
• We are now obligated to buy BCI shares @ $72.50 per share should
the option buyer choose to exercise the options
• Our initial profit from the put sale = $200/$7050 = 2.8% (less trading
commissions)
• This annualizes to a 34% return
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PREVIEW SCENARIO I
• If the price of BCI remains above the strike price (agreed upon sales
price of $72.50), the option buyer (holder) is not going to elect to exercise
the option and sell shares to us at a price lower than the current market
value.
• Option will expire worthless, we will have generated our 2.8%, 1-
month return and the cash is now freed up to secure another put sale the
next contract month.
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PREVIEW SCENARIO II
• Price of BCI does drop below the $72.50 strike price in which case the option will be exercised and
the shares sold to us.
• The cash previously deposited into our brokerage account is used for this purchase.
• The cost basis we now own this stock at is $70.50, the $72.50 we paid for it less the $2 put premium
we generated from the original option sale.
• At this point the put seller who is now the share owner can take one of the following paths:
• Sell the stock
• Hold the stock long term
• Write a covered call on the stock (giving the option buyer the right to buy these shares from us) to
generate additional income
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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)
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Factors That Influence “Moneyness” Decisions
• Identify our goal
• Overall market assessment
• Chart technicals
• Personal risk tolerance
• Calculations meet our initial goals (2-4%/month)
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“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
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“Moneyness” for Calls
• OTM- Most aggressive ($28/$30): highest potential returns
• ATM- Aggressive: highest initial returns ($30/$30)
• ITM- Most conservative ($32/$30)
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Portfolio Overwriting
• Covered call writing
• Avoid exercise
• Write OTM calls at least 5% OTM
• Lower return goals (eg: ½ 1% per month = 6% annualized)
• Avoid ex-dividend dates
• Roll options prior to expiration: 4 PM ET 3rd Friday of the month
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Summary to Master Option-Selling
• Must master all 3 required skills
1. Stock selection: (fundamental analysis, technical analysis, common sense principles)
2. Option selection: (“moneyness”, expiration date, returns meet goals)
3. Position management: (bullish and bearish scenarios)
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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
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