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Posts Tagged ‘Call option’

After Options Expiration

This past Friday, there were several happenings with my retirement portfolio as options expiration happened.  I had several calls expire, a few that were exercised and some puts that were exercised as well.  So let’s quickly run through the activity and explain what I plan to do for each of the positions in the portfolio.  I will start with the simple and work toward the more complex.

Expiring Call Options

I had several call options expire.  Some of the outstanding calls for Seadrill (SDRL), AK Steel (AKS), Seagate Technology (STX), DryShips (DRYS), and Intel (INTC) expired.  The plan will be to sell some more on a day when the market is showing a little bit of strength.  I already have some outstanding in-the-money calls on SDRL, AKS, and STX from when I felt that I should be a little defensive and raise some cash.  So I will likely sell some out-of-the-money calls in case the market is able to hang on into May.  Right now it is a little difficult to tell which way it will go, but I have a few weeks to see what happens.

I will also need to sell some calls on INTC when I get a chance.  I am using the stock as part of my dividend plan for 2012, but want to enhance the return by getting a little extra cash.  I am thinking that the stock has made a great run since August when I first purchased it and may be in for some sideways action.  Again, it is just one of those things that it may be worth sitting back for a week or so to see what happens.  If the stock drops some more, I could add to my position and pick up more dividends in the process.

Exercised Call Options

I did have some call options that were exercised on Friday.  Some of my stock in DRYS was sold at $3 and in STX at $28.  I was already able to buy some of the DRYS stock back yesterday at $3 so I managed to keep all the premium and not change my position on those shares.  I still have to buy some more back, but will be seeing what happens this week.  If it shows some strength, I might be able to sell some $3.50 calls.  If not, then I will sell some May $3 calls and try to pick up more shares at $3.

With STX, I still have quite a few shares and am counting on the dividends so I will be wanting to re-purchase those shares in the next few days.  I will probably sell some calls right away when I do since I will want to lower my basis.  This is a volatile stock in which I have already locked in a profit by purchasing May $25 put options.  So I can feel confident that whatever decision I make will only help and not hurt me.

Exercised Put Options

This is one of the more interesting trades to discuss, and I suppose the most complicated although it really isn’t that difficult.  I own shares of Silver Wheaton and have been trading it up and down over the past 14 months.  I am currently negative in the position due to a few rolls that I made so I am working to decrease the basis.  I had some April $36 and $35 calls expire meaning I kept some decent premium.

However, the stock has performed poorly enough as of late that my April $30 puts ended up being exercised.  Yesterday, I bought some May $25 puts and began getting back into my previous position.  I purchase some shares at $28.50 and a few more at $28.  That means those shares were sold at $30, and I was able to buy back at a discount.  As long as I am getting shares below $30, I am making a profit on that portion of the transaction.

The plan is to purchase a few shares here and there while seeing what the stock will do.  When I have a decent sense of what is happening, I will sell some covered calls to profit on that portion of the transaction and buy some more shares.  Ultimately, I will likely end up with more shares than I had started with for the same amount of cash expense.  Plus I will still have protection below $25 in case the bottom drops out.

If I can sell some May $29 or $30 calls and fill out the remainder of my position under $30 per share, I should end up ahead of where I otherwise would have been.  I will retain some shares against which I haven’t sold calls just in case there is a big run up in the stock as well.  Ultimately, I am needing to trim about $6 per share from the basis to get back into the black.  It will simply require a little bit of patience.  In the meantime, I can collect a few dividends on the stock.

So, do you have any investing plans heading into the summer?  Feel free to share or comment.

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4 comments - What do you think?  Posted by Cash Flow Mantra - April 24, 2012 at 9:04 am

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More on Covered Calls and Time Value

In the last post, we learned that the greatest time premium for a given expiration date occurs when the strike price is close to the market price.  So the relationship between these two prices ends up looking like a bell-shaped curve.  Now let’s look at another factor which influences the amount of time premium.

Time Until Expiration

It should only make sense that the amount of time premium should be greater if the amount of time is longer.  An option contract that expires in one month will cost less (or sell for less) than one that expires in one year.  Again using actual data at the time of this writing for Silver Wheaton stock (SLW), I have created the following chart of premium versus time for the call option with a strike price of 30.

Now at first glance it would seem that selling calls that expire in two years would be smarter than selling calls that expire in one month.  However, you have to remember that the graph is not to scale and to make a more fully informed decision, we should divide the amount of premium by the number of months until expiration.  When we do this, we find that the shape of the graph changes dramatically as you can see below.

So we could sell the call option expiring in 2 years for $8.65 per share, or the one that expires in a month for $2.02 per share.  When it expires, then sell the next one for $1-2 per share and repeat the process month after month making $30 or more in covered calls premiums over the course of two years.

Practical Application

For me, I am interested in making money from selling call options in my retirement account so I will sell them about one month out on average.  Sometimes I may wait to see if the market will have a good day and end up selling them 2 weeks away.  If I miss that window, I may end up selling covered calls that expire in 6 weeks.

Now if you want to purchase calls, then it is wise to purchase them to expire later so that you get more for your money, and the stock has more time to move in the direction that you would anticipate which would be higher.  After all, the way to profit from purchasing a call is to sell it at a higher price which can only occur when the stock increases in price.

Again, I think that this is a very important concept to grasp and understand, namely, the time value per unit of time is greatest with the options that expire sooner.  Feel free to ask any questions.

 

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12 comments - What do you think?  Posted by Cash Flow Mantra - January 18, 2012 at 5:30 am

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Selling Covered Calls and Time Value

I had a reader question last week about selling covered calls so I wanted to take the opportunity to offer up some practical tips regarding selling call options.  Now in the interest of disclosure, I want to explain that I am not a professional stock or options trader but have been trading for my own retirement account since 1999.  I have made plenty of mistakes so I can speak from experience.  So let’s get started.

Know What You are Selling

In order to profit from selling a covered call, you must realize that you are selling and attempting to profit from the time premium.   Now the money that you collect from selling a call option is called the premium which consists of the intrinsic value and the time value (time premium).  If the strike price of the call is less than the market price of the stock, then the difference actually represents a potential partial sale of the stock.

Using Silver Wheaton (SLW) stock as an example which closed Friday at $31.01 per share, I could sell the call expiring on February 18, 2012 with a strike price of $30 for $2.13 per share.  Of that, $1.01 is intrinsic value since I would be selling the stock for $30 versus selling it in the open market for $31.01.  The time value is $1.12 per share.

It seems logical then that to maximize profit from selling calls, you want to maximize time value.  This is true to an extent.  One must remember, however, that there are risks associated with attempting to seek the greatest reward as there are with any investment.  But one place to start is by knowing which factors can impact the time value and striking a balance between maximal reward and maximal risk.

Distance Between Strike Price and Market Price

Perhaps the most important factor affecting the time value of an option is the distance between the strike price of the option contract and the market price of the underlying stock.  Look at this graph that I created using the actual prices of the call options for the various strike prices of Silver Wheaton.  Remember that SLW closed at $31.01 on Friday.

Notice that the peak time value occurs at $31 per share which is almost equal to the market price of the stock.  Below that price, the premium is actually greater, but some of that is intrinsic value.  Just for fun, let’s do the same for Apple (AAPL) which closed at $419.81 on Friday.

The numbers are different but the shape is the same.  Try this with any stock (just make sure you subtract intrinsic value from the premium and only graph time value), and you will find the same general shape.  This is vital knowledge if you want to trade options!  The greatest time premium is for that option contract (put or call) whose strike price is closest to the actual market value at the time!  The graph will be a bell shaped curve.

I just want this to settle in and so will conclude the post here.  Contemplate this.  Get this embedded in your mind because this is an important relationship for trading options.  Next time, we will look at some factors which can cause this bell curve to move on the graph.

 

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10 comments - What do you think?  Posted by Cash Flow Mantra - January 16, 2012 at 5:30 am

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