[quote]on edge wrote:
I’m very skeptical of most peoples, mine in particular, ability to trade options.[/quote]
Good, you should be.
Nine out of ten people who trade options are going to be net losers. But you’re in an interesting situation in that you’re sitting on a large stock winner. In your case, selling covered calls (in this case, “covered” refers to the fact that you own TSLA stock) is akin to buying insurance on your house. At the end of the year, do you curse the fact that your house didn’t burn down? Is your premium wasted? No, it’s not. I would argue it bought you peace of mind.
So, I’m going to make this very basic. We’re only going to be concerned with calls and we’re only going to sell them. Theoretically, if you buy a call your upside is unlimited and your downside is limited to what you paid for the call. When you sell a call, your upside is limited to the money you receive for it called the premium, but your downside is umlimited. However, the difference is you actually own the stock so if the stock were to go up past the strike price, you would have the stock called away from you. But, you’d also have all the gains leading up to that.
For example, let’s say you’re sitting on 600 shares of TSLA. You love the story, you love the stock, but you know that the stock has had a meteoric rise since November and you know earnings are coming out on 2/19 so there might be some bumps in the road. Analysts are looking for 18 cents a share but everyone is focused on guidance.
You could buy puts to protect yourself from a downside move, but buying options is why nine out of ten people lose money. It’s like being a player in a casino versus being the casino. Or being the buyer of insurance versus being the insurance company. Instead, we’re going to sell 300 shares worth of the TSLA 225 calls expiring on March 22 for $7/share. We immediately have $2,100 deposited in our account.
Here are some possible scenarios come March 22:
TSLA is trading $225 - awesome. Your TSLA holding have gone up by $15,000 ($25/share * 600 share) and you get to keep the entire $2,100 you got paid.
TSLA is trading $200 - not bad. Your TSLA stock is unchanged, but you’re $2,100 richer from selling the calls.
TSLA is trading $175 - blows…but not as bad as if you didn’t sell the calls. Your stock is down $15,00, but you’ve collected $2,100 in premium mitigating some of the loss.
Here’s where things get interesting:
TSLA settle anywhere between $225 and $232. 300 share of your stock will be up between $25 and $32 per share for a gain between $7,500 and $9,600. The other 300 share will have been called away from you at a price of $225 for a gain of $7,500 plus you get to keep some portion of the $2,100 in option premium. This strategy is still an overall winner if the stock is below $232.
TSLA settles above $232 - well, your stock got called away from you at an effective price of $232 ($225 plus the $7/shr you earned for selling the options), but overall your still up over $19,200 and you still own half you position.
This strategy gets to be really fun when you start going out on the calendar. If I own 1000 share of XYZ trading for $40, I might sell 200 calls at $50 expiring in March, 200 calls at $55 expiring in April, 200 at $60 expiring in May, etc. If the stock never gets up to $50, I’m still collecting all that income every month. And, due to a wonderful phenomena called decay, every day that goes by increases the chances that the strategy will pay off. In fact, the decay is greatest in the last month. It’s so strong sometimes, that even an up day in the underlying stock isn’t enough to move the price of the calls higher.
Lastly, and this is the part that everyone fucks up, how do you get back in? Once I’ve had shares called away, I determine what price I’d want to own the shares at again and express that as a % of the current price. For example, TSLA goes up to $225, I think I’d be a buyer below $200 so that’s where I place my bid. BUT, I don’t just leave it there. $200 is %12.5 below $225 so every day the stock moves higher, I move my bid up so it remains %12.5 under the high. On a down day, I don’t move it down or I would never get filled. If the stock goes up as high as $257 without a %12.5 retracement, then my bid stays as $225 and I suffer the opportunity cost of not being in the stock.