Option Monetization Technique

           (selling covered calls)

 

The 3^rd potential monetization technique is a little more involved. It’s technically derivatives trading but specifically, I am referring to Options trading. “An option is a financial derivative that represents a contract sold by one party (the option writer) to another party (the option holder). The contract offers the buyer the right, but not the obligation, to buy (call) or sell (put) a security or other financial asset at an agreed-upon price (the strike price) during a certain period of time or on a specific date (exercise date).” A complete definition is at investopedia.com.

 

Without getting into too much detail about what it is, as noted, an options contract to buy the underlying asset is termed a call. While an options contract to sell the underlying asset is termed a put. Sticking with calls, an option contract can be bought similar to a stock asset. The difference being with the stock you own the asset. With the call option, you own the contract and thus the right to purchase the asset at a given price within a specified time limit. Thus if you are bullish (expect an increase in value in the stock asset) you can expend far fewer funds buying the option and potentially lock in the purchase of the stock at a future date. An example is in order.

 

 

(Buying Call Options)

Scenario 1

If stock A is valued at $50/sh and you expect the price to rise to $60/sh within 4 months you could theoretically but 1 call option contract (with a strike price of $50) for $10 ($100…call contracts are priced at 1/10^th of their stated value). This would give you the right (but not the obligation) to purchase the stock at $50/sh by the expiration date.

 

If the stock does indeed rise to $60 or close to it, the value of your option will increase say from $10 to $20.

 

Thus you have a decision:

• to exercise the option early (before the expiration date) and buy the stock at $50/sh.

• or sell the call option since its value has increased by 100%

• or hold the call option contract to term and exercise the contract (buy the stock) at the expiration of the contract

 

For any of the first three scenarios, you will have potentially made money on the trade.

 

Having said all of that, however, this is not the monetization technique I had in mind, though it is one in general.

 

 

(Selling Covered Calls)

The monetization technique I practice is selling covered calls. The word ‘covered’ basically means that you own the underlying asset. Recall that an option is a contract to…purchase / sell an underlying asset (stock). With the selling covered calls technique you are essentially ‘renting’ the stock to a perspective buyer for the stated period of time and giving the perspective buyer an opportunity to purchase it from you at a stated price. How does this earn money? Another example is in order.

 

Scenario 2

Say stock B is priced at $17/sh; you expect the price to increase to above $20/sh within 3 months. You could buy the stock outright and expend $1700 for 100 shares and hold until the price reaches that level or above. This is a typical buy and hold stock strategy.

 

Scenario 3 (same type as Scenario 1)

You could also buy the call outright which is priced at say $3.50 / contract. The call contract would cost you $350 and if the stock increased in value to $20 or higher you could exercise the call or sell it since the call option would have increased in value as well (the first technique ‘buying calls’ example I described on this page).

 

Scenario 4 (Selling Covered Calls – variation 1)

Or you could buy the stock for $1700 and simultaneously sell the call option contract to a perspective stock buyer for $3.50. This puts your expenditure of funds (not including trading costs) at $1350. If the stock price does indeed increase to $20 or above the option will likely be exercised on or before the call option contract expiration date, meaning you would have to sell the stock to the perspective investor for $1700.

 

But you keep the $350 that was paid to you in ‘rent’.

 

A real life example is in order from a trading position I made in 2014. In this case the stock price ended above the options strike price. Additionally, thru good screening I was able to get a stock that offered a dividend so I picked up a couple of dividend distributions during the option period.

 

Execution Date	Action Description	Quantity	Description	Price	Commission	Reg Fees	Total Cost	Basis
7/25/14	Buy	200	JNS – JANUS CAPITAL GROUP INC	12.37	8.95	0	-2482.95	-2482.95
7/25/14	Sell To Open	2	JNS Dec14 13 Call	0.85	12.95	0.08	156.97 (income)	-2325.98
7/25/14	Buy	100	JNS – JANUS CAPITAL GROUP INC	12.32	8.95	0	-1240.95	-3566.93
7/25/14	Sell To Open	1	JNS Dec14 12 Call	1.3	12.95	0.05	117 (income)	-3449.93
7/25/14	Buy	100	JNS – JANUS CAPITAL GROUP INC	12.37	0	0	-1237	-4686.93
7/25/14	Sell To Open	1	JNS Dec14 12 Call	1.35	0	0.04	134.96 (income)	-4551.97
8/22/14			JNS – JNS QUALIFIED DIVIDEND	0	0	0	32 (income)	-4519.97
11/21/14			JNS – JNS QUALIFIED DIVIDEND	0	0	0	19.76 (income)	-4500.21
12/19/14	Sell	200	JNS – Option Assignment	12	8.95	0.06	2390.99 (income)	-2109.22
12/19/14	Buy To Close	2	JNS Dec14 12 Call	0	0	0	0	-2109.22
12/19/14	Sell	200	JNS – Option Assignment	13	8.95	0.06	2590.99 (income)	481.77 (net profit)
12/19/14	Buy To Close	2	JNS Dec14 13 Call	0	0	0	0

 

Scenario 5 (Selling Covered Calls – variation 2)

The stock price could also drop and stay below $17/sh at contract expiration in which case the option contract will expire ‘worthless’.

 

Again you keep the $350 but now you own the 100 shares of stock which have now decreased in value. Let’s say the price drops and stays at $15 / sh. That means you’ve lost $200 on your stock purchase (bought the stock for $1700 and it’s now valued at $1500). But you earned $350 for selling the option contract. So you’ve still technically earned $150 if you closed out (sold the stock) the stock position at $15/sh.

 

Scenario 6 (Selling Covered Calls – variation 3)

Of course, the stock value could drop to $12/sh in which case you would have a total loss of $150 ($500 loss on the stock price but $350 earned for selling the option contract).

 

And this is what I luv about the selling covered calls monetization strategy, covered calls give you a buffer (insurance) of sorts and potentially limits the adverse impacts of a poor investing outcome.

 

Scenario 7 (Selling Covered Calls – variation 4)

The fourth scenario is that the stock price increases to $18.50/sh at contract expiration. In this case, the option would still expire worthless, in which case you would own a stock that has a $150 valuation increase plus have the $350 that the option buyer paid you for the contract. This represents a $500 increase in position value and to me is the most interesting position of all. After contract expiration your decision process might consider:

 

• claiming victory and closing out the position or

• parlaying into a new position (new options contract with the same assets at different price levels) or

• you could start a new contract with a completely different stock/option if screening conditions suggested a better opportunity

 

Okay, that’s a lot of information and a bit of detail. I will write more in a special post series but wanted to present this as a primer and a potential means of earning funds for fairly quick monetization of your business (hopefully an LLC or corporation).

 

If there are any errors in the presentation please let me know so I that can correct.

 

Also, please see the site disclaimer information before moving forward with any investment decision.

 

To go back to Monetization of your Corporation technique 1 click here.

 

To go back to the home or about page click here.

 

Save

Save