Strategy: Generate extra income from your shares with options
It is probably due to a lack of knowledge that some investors have never sold covered call options. Have you already decided at which level you want to sell (part of) your shares? Then this strategy could provide extra income!
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Shares and options
The usual way to start investing for many investors is by buying stocks and ETFs. One strategy is to buy and hold the positions for a long time. Not surprisingly, this strategy is called a buy-and-hold strategy.
If an investor’s strategy is to leverage the ups and downs of the stock markets, they might sell part of their investments at certain levels and buy again at lower levels. To ensure an investor always holds a position, they might want to keep a fixed amount of a specific stock in their portfolio. For example:
Price stock: 50 euro
Position: 1.000 stocks
200 stocks, sell @ 51 euro
200 stocks, sell @ 52 euro
His/her position might be reduced to the fixed number of 600 stocks if the stocks are sold first at 51 euro and later at 52 euros.
He/she could consider to buy the stocks back at a lower level, for example:
200 stocks, buy @ 49
200 stocks, buy @ 48
If the share price drops (under 48 euros), he/she could reach the original position of 1.000 stocks. The above-mentioned cycle would repeat itself. The difference in results compared to the buy-and-hold strategy could be significant. However, there is no guarantee that the price will drop after selling part of the investments.
Next to these possible extra results with selling and buying the stocks we have more options.
Options! Hugo invites you to have a look at the option prices of stock ABC, trading @ 50 euro, mid-June 2021
Let’s start with the goal to sell @51 and @52. The August-series (calls) show a mid-price of respectively 0,75 and 0,45. In case of assignment the prices including the option premiums will be 51,75 euro and 52,45 euro.
Of course, there are more expiry-dates to choose from, the December 2021 52 strike quotes 1,10. Of course this is almost 2,5 more than the August strike. But keep in mind that the duration of the December strike is around 3 times more (+/- 2 months <-> +/- 6 months)!
After assignment the investor can decide to directly sell put-options to buy back at the mentioned levels (49 & 48). But of course, he can decide to wait for a possible lower price. In this example we assume the stocks trades @50 again so we use the same option chain.
The August 2021 put 49 is trading @1,23 and the 48 @ 0,87. Meaning that after assignment the net price for buying back would be 47,77 euro and 47,13 euro. Take note: the December put 48 quotes around twice as much. However again, de duration is around 3 times longer (+/- 2 months <-> +/- 6 months)!
In case of assignments of the calls, followed by the assignment of the puts the total of the received premium (before costs) are:
- 200 * 0,75 = 150 euro
- 200 * 0,45 =90 euro
- 200 * 1,23 = 246 euro
- 200 * 0,87 = 174 euro
Of course, the result of the price movement itself is the same for both the regular investor as the investor trading options. So, selling 200 shares @51, 200 shares @52 and buying back @49 and @48.
Another very important aspect is selling the calls if the stock does not go up. The option premium is a benefit which the regular investor doesn’t get. He/she merely waits for the share to rise but does not benefit from a premium. The same goes for the put-options; the instructions of the ‘regular’ investor with limit-orders do not result in any benefit if the stock does not fall.
Hugo is convinced that options are ’financial miracles’ and that they contribute to achieving financial goals. However, like all financial products, options must be applied correctly and before using options its crucial to have sufficient understanding of the way they work.
In this particular strategy we used examples of selling options not for speculation but really as a tool for selling shares and buying them back. This means that the investor owns the shares to sell the (covered) call and has sufficient funds to buy the shares back through the put option.
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