Recent Option Trade

     When an individual buys a piece or real estate, they purchase insurance to protect them against huge financial burdens.  When a person buys a vehicle, they have to have insurance.  In fact, a person must show proof of insurance before they are even allowed to register the vehicle.  This has become a new norm in Canada over the past several years and assuming this will become the norm in other countries.

      Can you insure you retirement accounts?  More often that not, retirement accounts deal with mutual funds.  So these accounts are often not insured.  

       Can you buy insurance for your stocks?  The simple answer is yes.  If you own 100 shares of a stock, you can BUY a put option contract at a future expiration date and strike price.  Just like when you have car or home insurance, you pay a premium for this protection.  If no claim is made, you do not get the premium paid back to you.  

        The other side of  buying put option contracts is the put option seller.  The put option seller is the "insurance company" for stocks.   The seller of the option is paid a premium by the option buyer.  The seller of the put option is obligated to BUY a hundred shares of a stock for each put option contract that was sold on or before expiration date.  If the price of the stock stays above the strike price, the put option will not be assigned.

 

    The put option seller gets to keep the premium regardless if the stock goes up, down or side ways.  If the option is assigned, the option seller is put the stock at a lower adjusted cost basis.  This is because of the following formula:

 Adjusted cost basis = # of contracts*100 shares* strike price - net option + premium assignment fee 

     Not all brokerages charge an option assignment  or exercise fee.  Interactive Brokers does not charge this fee.

  

SUMMARY

   On August 23 2018, I sold 2 put option contracts in WestJet Airlines (WJA,TO).

number of contracts  : 2

Strike price : $17

Expiration Date :  September 21 2018 

Days to expiration:  30

Current Annual dividend : $0.56

Net premium received : $28.05
Option Assignement Fee:  $24.95

Scenario #1 - Option Not Assigned

Return =  $28.05 / ($3400)

            = 0.825%

At first glance, this return seems small.  This return represents the return for 30 days.  The annual return on my high interest savings account is 1.25%.

Annualized return = ($28.05 / $3400  ) *(365/30)

                               = 10.04%

Scenario #2:  Option Is Assigned

Adjusted cost basis = # of contracts * 100 shares * strike price -net premium + assignment fee
                                =2*100*17 - 28.05 + 24.95
                                = $3396.90

Yield = $0.56 / ($3396.90/200)
          = 3.297%

Let's compare this yield to the yield of purchase shares at $17 without an option.

My brokerage would charge a commission of $4.95 for 200 shares of stock.

Adjusted cost basis = $3400+$4.95

Yield = $0.56 / (3404.95/200)
          = 3.289%

Disclosure:  - Own 200 shares of WJA.TO
                    - Long WJA.TO

DISCLAIMER

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.