It’s actually quite simple. You’ll take your favorite stock that has had a good, strong run recently and buy it…but at the same time sell an ATM (at the money) call option against it. The first question you will ask yourself is why the hell would I sell calls against a stock I just bought for the same price I just paid? Simple: for the premium!
It’s Almost Like a Straddle
Buying stock and selling an ATM call is almost like straddling the stock with a put / call straddle trade. You own the shares and sold the ATM calls against them (meaning someone can call those shares away from you at expiration for the price / strike you sold them for) and all you have to do is wait.
If the stock sits still and trades sideways until expiration you make money. If the stock continues higher you make money. If the stock drops you lose money on the shares, but it’s offset by the money / premium you are paid on the calls down to your break even. Then you can just buy the calls back (or let them expire worthless) and ride the stock back up. We all know eventually a stock will go back up if you’re buying good companies.
Let’s look at Micron. It’s been on fire lately and more than likely it’s heading higher for at least the short term. Let’s take $25,000 at 2:45 PM today (15 minutes before the close) and purchase 600 shares @ $41.65 and SELL the November expiration (30 days) 41 CALL option at the same time. This would be considered a “covered stock” purchase because the shares are somewhat “covered” to the break even price if the stock turns South.
This means that you just paid $41.65 per share, but by selling the call you’re obligating yourself to hand over those shares on expiration day to Joe Bob Blue for $41 IF the stock is above $41 on that day. You might be asking: wouldn’t this trade lose money? Well, yes, if that’s all that was happening here. However, you were paid by Joe Bob Blue $2.26 per share to provide him that right (to take your shares at $41 per share). That’s the premium we’re being paid and that’s what we’re really after!
How to Calculate the Trade
Using simple math we can easily calculate the profit: You paid $41.65 per share. You were paid $2.26 per share from Joe Bob to call them at $41. When he calls them you will lose 65 cents per share, but you were paid $2.26. Therefore, your profit is $2.26-.65 or $1.61 per share. Keep in mind, your break even is $41-$1.61 or $39.39. If you believe Micron will remain above $39.39 for the next 30 days then this trade is for you and you will not lose money.
The total profit for the trade is $1.61×600 shares or $966.00 (before commissions of $11.45). So think about it: you just bought stock for $41.65 and sold calls below your cost basis and as long as the stock is above $41 per share (lower than you paid) in 30 days you’ll still make $966.00 profit on $25,000. That’s 3.92% for 30 days! Very easy and you make money even if the stock sits or even dips slightly! You even have a little downside protection to $39.39. If you’re comfortable holding Micron why would you NOT do this? Yes, the stock can gap up to $44 per share and you will not capture that gain, you will still only make $966.00, but so what? You’re still beating every money manager in town with your return.
It’s All About the Premium
This trade is all about the premium paid to you, the seller of the option. It’s not about making money on the shares of stock. We don’t care about that. We only care about the premium. This is what I call a reverse cash-secured put trade. It’s still a somewhat bullish trade, but instead of selling puts and being put the shares you sell calls against stock you buy / own.
Why not just sell puts? Well, it’s all about the current situation. With General Electric (GE) I would be selling puts because the put premium is elevated due to being beat down lately. It’s also close to earnings so the implied volatility is high. Sell the Dec 20 puts with GE. Micron on the other hand is at all-time highs. You can’t sell puts against it because the premiums suck because it continues to go higher. The call premiums are elevated and we want to take advantage of that so we sell calls. It’s dangerous to sell naked calls so we buy the stock purely to cover the calls we’re selling for the premium. Makes sense right? ha!
Big Money Trading
To give you a little more of a reason: if you’re trading with $450,000.00 this trade would make you roughly $17,500.00 for 30 days or, again, 3.92%. That percentage gain is what most people make annually and you can easily do it in 30 days.
What if it goes wrong?
If Micron tanks 8% it would be around $38.30 per share. You would be down, but not out. You’re going to own nearly 11,000 shares with a real cost basis of $39.39 so you’ll be down rougly $11,000.00. If this happened you would have two choices: sell the shares immediately if you think Micron is going lower and take the $11,000 loss or hold until it moves a little higher and sell more calls for the next available expiration.
Due to the lower cost basis of $39.39 even if Micron fell 8% your total $450,000.00 portfolio would only be down 2.4% or $11,000.00. It won’t be hard to make up 2.4%. In fact, Micron would probably come right back and as soon as it got near $40.00 per share I would be selling the 40 or 41 calls.