LEAPS option - Is this a good use?

M

macanoni

Hi,
I am a Buy-and-Hold, value investor, interested in learning more about options.
Got a hypothetical question, want to ask some opinions from the experts here.
I own 1000 shares of a stalwart, value stock. It has appreciated 80% since purchase (2 yrs ago). I got a stop loss order to protect my gain (60%). Normally on the upside, I would sell at certain price as part of re-balancing my portfolio at some regular interval.
I am wondering if I can sell LEAPS call option to get some extra gains as well.
My strategy is to sell 5 call contracts 15 mths out, at a price that would cap my gain roughly at 5% above the 52-wk high that I missed earlier this year. I know if the stock goes up beyond that, I am missing an opportunity for further gain. But I am doing it as a way to re-balance my portfolio anyway so I am willing to part with them. If the stock price won't reach the strike price in a year time, then I get to pocket the premium and still have the stock. This is a stock that I am willing to hold long term (5 yrs or more. The stock is fundamental sound). I can evaluate when the expiration date is near to see if I need to adjust accordingly.
What are the pros and cons with this that I have not thought of?
(I am also choosing LEAPs over normal month-to-month covered call since I don't have the time to monitor them and don't want to be stressed about it. Since it's a value stock, the option price for the month long covered call also doesn't fetch much for me to be bothered.)
Any advice is greatly appreciated!
 
No, if you have such a long horizon, doing covered calls with leap is not a way to go. rather, a bi-weekly or monthly covered calls will perform better.
It also depends on whether you want to keep the cash flow income or add positions on the same stocks. You can sell the short dated covers calls and use the premium to buy leap on the same underlying, essentially add to your exposure, assuming of course the stock is directionally going up.
 
macanoni said:
Hi,
I am a Buy-and-Hold, value investor, interested in learning more about options.
Got a hypothetical question, want to ask some opinions from the experts here.
I own 1000 shares of a stalwart, value stock. It has appreciated 80% since purchase (2 yrs ago). I got a stop loss order to protect my gain (60%). Normally on the upside, I would sell at certain price as part of re-balancing my portfolio at some regular interval.
I am wondering if I can sell LEAPS call option to get some extra gains as well.
My strategy is to sell 5 call contracts 15 mths out, at a price that would cap my gain roughly at 5% above the 52-wk high that I missed earlier this year. I know if the stock goes up beyond that, I am missing an opportunity for further gain. But I am doing it as a way to re-balance my portfolio anyway so I am willing to part with them. If the stock price won't reach the strike price in a year time, then I get to pocket the premium and still have the stock. This is a stock that I am willing to hold long term (5 yrs or more. The stock is fundamental sound). I can evaluate when the expiration date is near to see if I need to adjust accordingly.
What are the pros and cons with this that I have not thought of?
(I am also choosing LEAPs over normal month-to-month covered call since I don't have the time to monitor them and don't want to be stressed about it. Since it's a value stock, the option price for the month long covered call also doesn't fetch much for me to be bothered.)
Any advice is greatly appreciated!
More...

You can sell 1 call option for each 100 shares you own of the stock. In this case, you can sell 10 contracts or did you intend to just sell call options on 500 shares? Also, LEAPS are longer term call options, assuming this stock is trending up longer term, the chances of it being in the money would probably, be higher at expiration. Stop loss orders would not protect your stock if it gaps down. It will blow thru your stop loss and you will lose a larger amount. A better option in my opinion is to buy put options at a higher strike price. Say your stock is at $100 and you buy a put option at $120 for the next 3 months and it cost you $500. That guarantees you are able to sell your stock at $120 even if your stock gaps down to $60 for instance. The cost of the put options in this example would be $500 x 10 contracts is $5,000. It may be too steep of an insurance to pay but, if you are able to lock in say 100% gains on your stock, you would be glad to pay the cost of the put options. Now, this can go either of two ways, your stock continues to go higher and now is at $150. Your put will still allow you to get out at $120 if it drops for whatever reason. If it goes higher to $200, you could elect to buy a higher strike option at $200 and pay say $600 per contract x 10 = $6,000 to insure your position for the next 3 months. Sell the residual value of the $120 put option whatever it is. Say, there is $100 left per contract x 10 = $1,000 left. You can put it back into your pocket and offsets $1,000 of the cost of your higher strike $200 put option. Buying put options cuts into your profits but, locks in that profit at higher and higher stock prices. A way better option than just relying on a stop loss considering you already have 80% gains?
 
mervyn said:
No, if you have such a long horizon, doing covered calls with leap is not a way to go. rather, a bi-weekly or monthly covered calls will perform better.
It also depends on whether you want to keep the cash flow income or add positions on the same stocks. You can sell the short dated covers calls and use the premium to buy leap on the same underlying, essentially add to your exposure, assuming of course the stock is directionally going up.
More...
The problem is I am not good at setting a good strike price. If I set it too high (OTM), the premium is very low, not worth doing it. If I set it low, ATM or near the money, I would have to part with my stocks right now which I am not willing to do. The stock is defensive so I would like to keep it in the near future (6mths) as I don’t see good alternative if I am forced to sell the stock and left with cash earning nothing.
 
smallfil said:
You can sell 1 call option for each 100 shares you own of the stock. In this case, you can sell 10 contracts or did you intend to just sell call options on 500 shares? Also, LEAPS are longer term call options, assuming this stock is trending up longer term, the chances of it being in the money would probably, be higher at expiration. Stop loss orders would not protect your stock if it gaps down. It will blow thru your stop loss and you will lose a larger amount. A better option in my opinion is to buy put options at a higher strike price. Say your stock is at $100 and you buy a put option at $120 for the next 3 months and it cost you $500. That guarantees you are able to sell your stock at $120 even if your stock gaps down to $60 for instance. The cost of the put options in this example would be $500 x 10 contracts is $5,000. It may be too steep of an insurance to pay but, if you are able to lock in say 100% gains on your stock, you would be glad to pay the cost of the put options. Now, this can go either of two ways, your stock continues to go higher and now is at $150. Your put will still allow you to get out at $120 if it drops for whatever reason. If it goes higher to $200, you could elect to buy a higher strike option at $200 and pay say $600 per contract x 10 = $6,000 to insure your position for the next 3 months. Sell the residual value of the $120 put option whatever it is. Say, there is $100 left per contract x 10 = $1,000 left. You can put it back into your pocket and offsets $1,000 of the cost of your higher strike $200 put option. Buying put options cuts into your profits but, locks in that profit at higher and higher stock prices. A way better option than just relying on a stop loss considering you already have 80% gains?
More...
I only want to do 5 contracts (500 shares). I want to keep the other 500 shares intact. Doing it this way meaning I am buying put DITM? does it mean it will auto-exercise at expiration if I don’t do anything?
I need to calculate the cost to see if the offset of the gain is not so bad. I am not used to do short-term trades that require rolling things out further and erode my gain if I am not doing it right. How many months out is the right amount of time for this strategy? I don’t think this value stock is going to shoot up very high in the next year. I bought them at a deep discount during the pandemic so that’s why I have a large gain. I am content to keep 1/2 of them since it pays good dividends and is part of my core portfolio. I am only selling part of them to rebalance the portfolio and try to make as much of a profit as I can in the process.
 
macanoni said:
I only want to do 5 contracts (500 shares). I want to keep the other 500 shares intact. Doing it this way meaning I am buying put DITM? does it mean it will auto-exercise at expiration if I don’t do anything?
I need to calculate the cost to see if the offset of the gain is not so bad. I am not used to do short-term trades that require rolling things out further and erode my gain if I am not doing it right. How many months out is the right amount of time for this strategy? I don’t think this value stock is going to shoot up very high in the next year. I bought them at a deep discount during the pandemic so that’s why I have a large gain. I am content to keep 1/2 of them since it pays good dividends and is part of my core portfolio. I am only selling part of them to rebalance the portfolio and try to make as much of a profit as I can in the process.
More...

Just my 2 cents. I think you are better off protecting your position with put options instead, of selling calls against your stocks. Any premium you collect from the calls will not be enough if your stock drops a huge amount. Put options will guarantee you get out at a set price, within the life of the option. You can reduce the cost by buying way out of the money put options instead of ATM put options. It will still protect your position but, the risk to losses would be larger. So, if the stock is a $100, instead of the $120 put option, you can elect to buy the $80 put option which costs less. It would function like a stop loss but, it guarantees you are able to get out at $80 even if the stock say, gaps down to $60. A stop loss will get you out at $60.
 
IMHO it's ok (selling LEAPS calls against 1/2 your position) from an investing standpoint. IOW you were just going to keep the stock, or let it go at the short call's strike price. In most market conditions continued trading of the so-called Wheel (sell puts, when assigned sell calls, etc) in a short term way is nearly guaranteed to under perform most other methods. Doing it your way will at least add some gains if stock goes up and slightly lessen losses if stock drops. If you trade in and out of it a lot you will probably lose.

BUT don't forget you will pay cap gains on those shares if the calls are assigned. If you REALLY love this stock and you wouldn't mind buying more, then another game you could play is to sell LEAPS puts OTM at the same time as the calls. If the stock goes up you keep short put prem and short call prem, but possibly get the shares called . Stock goes down you keep both prems again, but possibly buy another 500 shares at the put strike. The prems can offset some losses, but of course the danger here is you are possibly doubling up on your position. It's easy to say "But I wouldn't mind buying more if it dropped to the put strike..." but would you REALLY still want to if the stock turns into a disaster? What if it drops 50% under the put strikes?

Anyway, adding LEAPS calls/puts prem with a LONGER TERM mindset could add a couple percentage points profit potential. There are of course lots of gotchas and things to think about. Good luck. :)
 
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