Options provide an opportunity to improve the returns in your investment portfolio by selling them against stock and ETF positions you already own. By selling options against these positions, you can not only improve the cost basis with a steady stream of monthly income but hedge your positions against market drawdowns by the lowering of your cost basis in a stock or ETF.
Most investors in the financial markets are “buy and hold”. They buy a stock or ETF, sit on it while waiting for it to increase in value. The US Equities markets have an upward bias over a long period, but most investors have experienced a material drawdown in their investing life.
Most investors have no clue about how to use options to provide a monthly cash flow and to protect their holdings against market corrections. And if the investor is using a financial advisor, you can bet the so called “expert” has not even introduced option selling and/or hedging to his or her clients.
Ask yourself why, if you have a stock sitting in your portfolio, you would not take advantage of bringing in an extra 2% plus or minus each month? It really is a very simple process. Let’s assume you purchase 100 shares of AAPL in your portfolio. The stock is currently trading at $138 per share. That is a total investment of $13,800.
You now sell one option contract in the front month at the 150 strike price. You now have a contract with the buyer of the option that you will deliver 100 shares of your AAPL stock on options expiration day (usually the 3rd Friday of each month) for $150.00 per share. For selling that option, you receive $3.00 per share into your brokerage account immediately at trade execution. Now you have an additional $300.00 of cash in your account and you still own 100 shares of AAPL.
Now let’s look at potential scenarios:
1. You have instantly lowered your cost of AAPL by $3.00 per share. Now your cost basis is $135.00 per share. You can absorb a $3.00 per share decline in the stock's price and your portfolio still is worth $13,800.
2. The price of AAPL moves around but remains under the $150.00 strike price of the option you sold. On expiration day, the option contract that you sold expires worthless and you have no further obligation under the contract.
3. The price of AAPL closes above $150.00 on expiration day. By contract, you deliver the stock and you receive $150.00 per share, receiving $15,000 resulting in a profit of $1500.00 (15,000 - 13,500). Of course you potentially give up some upside if AAPL goes above $150.00 per share, but remember, your breakeven price is $153.00 ($150.00 you receive for the stock plus the $3.00 you received in premium. If you want to keep the stock, you can roll the option out to the next expiration cycle and usually for a credit.
What I have outlined here is for one month. Let’s say you can collect $3.00per share per month for a year. By selling covered calls each month, you will bring in $3,600 plus or minus, reducing your cost to about $100.00 per share.
If this sounds challenging, it really is not. One advantage to becoming an OptionsMeister Gold Level member is the opportunity to discuss your specific investment questions in real time and get your answer in a matter of minutes.
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