Tuesday, March 28, 2017

Option Trades : Trade #1

      Earlier in the day, I placed limit order to try to collect some option premium(s).  Investors receives option premiums in the derivatives (aka options ) markets when he or she sells an option.  If an investor is bullish on a stock, the investor can reduce their risk by buying a call option or selling a put.  The investor will receive the premium minus commissions for only do the latter.  If an investor is bearish on a stock, the investor can reduce their risk by buying a put or selling a call.  Again, the investor receives option premiums for only the latter. Selling puts or calls are the basic ways an investor can receive option premiums.  There are also different types of option  trades which are more advanced.

    I am going to talk about one of these trades below. 

    Sometimes a stock falls in price a lot which can mean a buying opportunity if you previously researched a company.  After careful research an investor can decide on a price they are willing to purchase shares of this company. Did I do this?  No, I did not.  I quickly glanced at the chart this morning.  Prior to the opening bell this morning,  Home Capital Group fired its CEO over night.  The stock price fell a lot  due to the recent past events of the company coupled with the firing of their CEO.  The stock fell approximately 10% and then rebounded to finish down 9.60% to close at $25.06 per share.

      I set a limit order, after the markets opening, to sell 2 put option contracts with an April 21, 2017 expiration date and strike price of $25.00 strike price.  I collected a total of $128.05 after commissions.


 Scenario #1:   Option Not Assigned

Premiums collected:  $128.05
Strike Price : $25.00
# of contracts : 2
Days to expiration:  25 days

Total Return = $128.05 / (5000-$128.05) 
                      = 2.63%

This return of 2.63% is for 25 days.

Annualized Return =[ $128.05 / ($5000-$128.05)] *[365/25]
                               = 38.4%

     Currently, the interest rate on my high interest savings account is 0.80% per year.  The return on this option definitely is a lot better, plus more tax efficient.  Of course, the low interest rate on my savings account is a lot less riskier to the downside.  Can an investor protect his downside when selling a naked put option?  An investor can BUY a put option for insurance at a lower premium and a strike price that is lower.  The lower strike price would mean smaller premium out of pocket as it is more out of the money.  Buying a put option for insurance  with the premium collected from the short put, means an investor reduces risk if he or she is wrong.  I have not done this, but will definitely consider it.

Scenario #2:

     The option could be assigned on or at expiration.  My adjusted cost basis would be reduced in an amount equal to the premium collected minus commissions.  Therefore, my yield would be greater than if I just bought the stock at $25.00

Note: I will update my investing tab spreadsheet in early April to reflect this transaction

I am not a financial planner, financial advisor, accountant or tax attorney. The information on this blog represents my own thoughts and opinions and should NOT be taken as investment or business advice.

Every individual should do their due diligence to make their own financial decisions based on their financial situation and tolerance for risk.

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