How To Generate Monthly Cash Flow And Purchase Stocks At A ...icrjc/AAIIPHX/Mar18slides.pdf · Definitions Call option-Gives the holder the right, but not the obligation to buy 100

How To Generate Monthly Cash Flow And Purchase Stocks At A Discount Using Two Low-Risk Option Strategies

Covered Call Writing and Selling Cash-Secured Puts

Hosted by:Dr. Alan Ellman, President of The Blue Collar Investor Corp.

www.thebluecollarinvestor.com

[email protected]


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Strategy Overview

• Sell call and put options to generate monthly cash flow

• Sell OTM puts to buy stocks “at a discount”

• Sell OTM call options to enhance returns for a buy-and-hold portfolio

• Use both covered call writing and put-selling to develop a multi-tiered option selling strategy

• Zero-dollar collar to protect low cost basis stocks

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Three Essential Skills

•Stock or ETF selection

•Option selection

•Position management


Definitions

Call option- Gives the holder the right, but not the obligation to buy 100 shares of stock at a fixed price by a specified date. Call options will be used in the PCP (put-call-put) strategy

Option- A contract that gives the holder the right, but not the obligation, to buy or sell 100 shares of stock at a fixed price (called the strike price) by a specified date (called the expiration date). It is the right to execute a stock transaction.

Put option- Gives the holder the right, but not the obligation to sell 100 shares of stock at a fixed price by a specified date.


“Moneyness” Of An OptionRelationship of the strike price to the price of the stock

Puts (Stock $/strike $)

• OTM ($32/$30)

• ATM ($30/$30)

• ITM ($28/$30)

Calls (Stock $/strike $)

• OTM ($28/$30)

• ATM ($30/$30)

• ITM ($32/$30)


Option Premiums In Relation To Stock Price

• Premium = intrinsic value + time value

• Intrinsic value = amount ITM (only for ITM strikes)

• Time value: Total premium – intrinsic value

– Stock $56

– Strike $50

– Premium $8

– IV $6

– TV $2

• All premiums consist of time value only for ATM and OTM strikes


Preview Example For Calls

• Purchase 100 shares of Company XYX @ $48 per share = $4800.

• Sell an option: sell someone the right to buy these shares for $50 per share during the next month.

• You are paid a premium of $1.50 per share = $150.

• This is a 3.1% 1-month return = 37% annualized.


PREVIEW SCENARIO I

• At the end of the month, the stock price is less than $50; your shares are NOT purchased.

• You keep your 3.1% 1-month profit and are free to sell another option.


PREVIEW SCENARIO II

• At the end of the month, the stock price is above $50 per share and your shares ARE purchased.

• You now make an ADDITIONAL $200 on the sale of the stock.

• Total 1-month profit is $350 = 7.3% 1-month return = 87% annualized!


Preview Example For Puts• Stock BCI is trading @ $75

• The out-of-the-money $72.50 put is selling for $2 for a 1-month

expiration

• We deposit $7,050.00 into our cash brokerage accounts per 100

shares of obligation

• We sell the put option for $200 per 100 shares of obligation

• This option premium is ours to keep no matter what transpires by

the end of the contract

• We are now obligated to buy BCI shares @ $72.50 per share should

the option buyer choose to exercise the options

• Our initial profit from the put sale = $200/$7050 = 2.8% (less trading

commissions)

• This annualizes to a 34% return


PREVIEW SCENARIO I

• If the price of BCI remains above the strike price (agreed upon sales

price of $72.50), the option buyer (holder) is not going to elect to exercise

the option and sell shares to us at a price lower than the current market

value.

• Option will expire worthless, we will have generated our 2.8%, 1-

month return and the cash is now freed up to secure another put sale the

next contract month.


PREVIEW SCENARIO II

• Price of BCI does drop below the $72.50 strike price in which case the option will be exercised and

the shares sold to us.

• The cash previously deposited into our brokerage account is used for this purchase.

• The cost basis we now own this stock at is $70.50, the $72.50 we paid for it less the $2 put premium

we generated from the original option sale.

• At this point the put seller who is now the share owner can take one of the following paths:

• Sell the stock

• Hold the stock long term

• Write a covered call on the stock (giving the option buyer the right to buy these shares from us) to

generate additional income


3-Pronged Approach To Creating A High-Quality Watch List

• Fundamental Analysis: Earnings and revenues

• Technical analysis: Reading a price chart

• Common sense principles (diversification)


Premium Stock Screen


Premium Watch List: Weekly List


Option Selection:“Moneyness” And Expiration (1-month)


Covered Call Writing Returns


Put-Selling Returns


Factors That Influence “Moneyness” Decisions

• Identify our goal

• Overall market assessment

• Chart technicals

• Personal risk tolerance

• Calculations meet our initial goals (2-4%/month)


“Moneyness” For Puts

• First establish goal (income only, buy @ discount, use with ccw)

• *OTM- Most conservative ($32/$30)

• ATM- More aggressive ($30/$30)

• ITM- Most aggressive ($28/$30): exercise most likely


“Moneyness” for Calls

• OTM- Most aggressive ($28/$30): highest potential returns

• ATM- Aggressive: highest initial returns ($30/$30)

• ITM- Most conservative ($32/$30)


Integrating Both Strategies: PCP Strategy




Portfolio Overwriting

• Covered call writing

• Avoid exercise

• Write OTM calls at least 5% OTM

• Lower return goals (eg: ½ 1% per month = 6% annualized)

• Avoid ex-dividend dates

• Roll options prior to expiration: 4 PM ET 3rd Friday of the month




Using a Zero-Dollar Collar to Protect Low Cost Basis Stocks



Summary to Master Option-Selling

• Must master all 3 required skills

1. Stock selection: (fundamental analysis, technical analysis, common sense principles)

2. Option selection: (“moneyness”, expiration date, returns meet goals)

3. Position management: (bullish and bearish scenarios)









Covered Call Writing And Put-Selling

Generate Monthly Cash Flow using Two Conservative Option Strategies

Hosted by:Dr. Alan Ellman, President of The Blue Collar Investor Corp.


[email protected]


38

http://www.thebluecollarinvestor.com/

Documents

How To Generate Monthly Cash Flow And Purchase Stocks At A ...icrjc/AAIIPHX/Mar18slides.pdf · Definitions Call option-Gives the holder the right, but not the obligation to buy 100