In the previous post, I discussed a strategy which enable us to reduce cost base in acquiring great value stocks. In this post, I will discuss a strategy which we can use when we are holding the shares. I will use the example given in the last post to illustrate this concept. Hence, if you haven't read the previous post, you may want to go through it first.
Imagine now we have 100 unit Apple shares, which we bought at $108 per share and the stock is trading range-bounce with resistance $110 (In other words, it means Apple stock will find difficulty to trade above $110 base on technical chart/analysis due to market psychology). We can sell to open a Call options at $110 with 2 months date to expiry and collect a premium, say $1 per options contract. There are three scenarios when this options matured.
Scenario 1: if Apple stock trades at $100 (below Options $110 strike) when options is matured (Options OTM)
We are happy to pocket $1 premium and we can consider to initiate another sell to open Call options to collect the next premium. At this point of time, we have further reduced the cost base from the original buying price of $108 per share to $107 per share ($108 - $1 premium). We can also look at this from another dimension, where we are making $1 out of $108 in two months, which give us a yield of 5.56% per annum.
Scenario 2: if Apple stock trades at $110 (equal to Options $110 strike) when options is matured (Options ATM)
Most brokers would exercise ATM options, which means as this call options seller, we need to sell the stock at $110 to the options buyer. When this happen, we will profit $3 per shares ($110 selling price - $108 buying price + $1 premium). If you are still happy to hold the shares, you can easily buy to close the call options before the maturity. If you buy to close the call options at $0.10 per share, you are still collecting the premium of $0.90 ($1 - $0.10) per share.
Scenario 3: if Apple stock trades at $115 (above Options $110 strike) when options is matured (Options ITM)
Our ITM options will get assigned, which means as this call options seller, we need to sell the stock at $115 to the options buyer. When this happen, we will profit $3 per shares ($110 selling price - $108 buying price + $1 premium). Do note that our profit potential is capped at the options strike price. We will still profit $3 per shares even if Apple stock goes up to $200 when the options matured. We can consider the technique of rolling-over the options if we prefer to hold the stocks. I will explain more on this technique in the next post.
In summary, regardless of which scenarios happen, we are still either making a good profit or reducing our cost base further. This demonstrate the power and the flexibility of using options to enhance our portfolio! I hope I have stimulated your interest to learn further to add options to your trading/investing journey by now! Cheers!