Use access key #2 to skip to page content.

TMFPostOfTheDay (< 20)

In Support of Options



March 22, 2012 – Comments (0)

Board: Real Estate Investment Trusts

Author: JoKingMe

A reply to BruceCM.
I sell options for income.
My original posts on using options for income:

I've also published presentations from BMWM conferences at this site:

I look at all investments as income investments regardless of the underlying dividend.

My goals: Increase income by at least 4% per year and live off the income from the portfolio without having to sell anything.

My priorities are:
1. Income
2. Income Growth
3. Conservative Investments
4. Capital Appreciation

Covered Calls fit nicely into #1-3, but do limit #4 some.
PUTs fit #1-3. Yes, #2 as I can used PUT premiums collected to purchase more dividend/income stocks.

BruceCM said: " Selling covered calls. The kind of standard line I've read from others who do this is you'd want to do this if it is a stock you'd be willing to sell at today's price anyway".

Very rarely do I sell at-the-money (ATM) covered calls. The example in my original post of selling an HCN Sep2012 $60 covered call had 10.7% stock price upside (out-of-the-Money covered call (OTM CC)). So NO, I'm not willing to sell the stock at the current price, but 10% higher is another subject.

My goal is additional income without losing the stock.

Let's revisit the HCN example from the first post. The total return if called was 14.7% (30.2% annualized) for 6+ months. HCN required a 21.5% stock price CAGR for 191 days exceed $60 by the expiration date of 9/15/12. Making this kind of return for a near term position is pretty good, so I'm willing to accept the call away risk.

I infrequently use the strategy of 'buy/write' where I purchase a stock and sell an immediate covered call in my taxable accounts. I prefer to purchase a stock at what I believe is a good price, wait for some appreciation and then sell an OTM covered call. The HCN shares where I recently sold the Sep2012 $60 CC were purchased in Nov2011 for $47.25. My total return will be 34.5% if I'm called away in September at $60. I can live with the "mistake" if these shares are called away.
What happens if the stock is above your strike at expiration?
1. If you do nothing the shares will be called away. Simple and you move on.
2. You can roll the option up and out. Say you own 100 shares of DEO with a Mar12 $95 CC sold against it. Stock at $96.27 would be called unless you close the position. You could have closed the option for say $1.30 (no time value) and sell an Oct12 $100 for $3.20+ (all time value). You'd net another $1.90 in options premium, give yourself another $5.00 in upside and capture another dividend (semi-annual in this case). Not the worst possible outcome. You keep the income stream rolling with more upside. This door is usually available if you sell CC's with a fair amount of upside. The more the option is ITM (in the money) at expiration the harder this becomes.

BruceCM: "The other problem I have with selling covered calls is who is the buyer? What does he know that I don't? Why is he buying it?"

I don't know what they know and I don't care. One very important concept with covered calls is it is possible for both parties to make money. As the seller of the call I collect premium while restricting my upside and accepting the downside. The buyer of my calls is making a significant upside speculation on the stock. Back to the original HCN example. Say HCN is $62 in Sep2012. I'll have made $7.94 per share (upside+dividends+premium) where the buyer will have made $1.35 per share. Of course, I'd only made 14.7% on my $54.19 while they made 200% on their $.65, but we both made money.

Selling PUTs.
I tend to do this just the opposite of selling covered calls. I want the stock to be down below its longer term trend and have favorable valuation and be a very desirable purchase at the PUT strike.
Just like CC's, I want all of my PUT positions to expire worthless. My goal is income, not stock ownership.
I consider PUTs a conservative part of my portfolio.

HCN is not priced where I'd want to initiate a PUT position today, in fact very few stocks look cheap to me at this time. I hope I'll be patient enough to wait for good PUT selling opportunities to replace the PUTs that expired Friday.


I sell options to create extra income at low risk.

It is important for those using options to understand the risks and rewards accepted with options.
As the seller of OTM options, I'm selling 100% time value. Time decay is my friend and each passing day erodes the time value of my short option positions. One of my favorite songs: Time is on my side. Yes it is!!

I hope this answers some of Bruce's questions,

0 Comments – Post Your Own

Featured Broker Partners