from Philip Davis at seeking alpha...
buying 500 shares of ABX TODAY, for $17.79 ($8,895) and selling five 2019 $15 calls for $5.70 ($2,850) and $15 puts for $2.40 ($1,200).
Your net entry is $9.69 ($4,875) and, on January 18th, 2019, (720 days), you will either be called away at $15 with a $5.31 profit (54.7%) if the stock is above $15 or, if ABX is below $15, you will be assigned another 500 shares at $15 ($7,500) leaving you with 1,000 shares at $12.375, which is 30% below the current price. Owning the stock for a 30% discount is your worst case!
we want to find stocks that are likely to stay in a channel. Stocks that have decent volatility day to day (to boost the price of the options we sell) but are not too likely to stray from a trading range of maybe 20% up or down. Wal-Mart (NYSE:
WMT) comes to mind, McDonald's (NYSE:
MCD), Verizon (NYSE:
VZ), AT&T (NYSE:
T), F... Blue chips are good when you are beginning, as they are less likely to go to zero
I still like Ford, because F is only $12.49 a share so anyone can play with it. Option contracts trade in 100-share blocks so SELLING 10 of the 2019 $12 put for $1.92 ($1,920) obligates you to buy 1,000 shares of F for $12 ($12,000) and puts $1,920 in your pocket right away. That nets you into the stock for $10.08, which is giving yourself a quick 19.3% discount (see "
How to Buy a Stock for a 15-20% Discount").
You can then conservatively buy 1,000 shares the stock for $12.49 ($12,490) as well and that would put you in at a net of $10.57 a share and, if F goes below $12 and the 1,000 shares are assigned to you from the short puts, then you end up with 2,000 shares at an average of $11.285 ($22,570) - that's your maximum risk on the trade (and F is not likely to go to zero, of course). Now you can sell 10 2019 $12 calls for $1.80, putting another $1,800 in your pocket, so the total cash outlay drops to $8,780
If you are called away in January 2019 at $12, you get paid $12,000 in cash, keep the $1,920 from selling the calls and the $1,800 from selling the puts. That would be a profit of $3,230, which is 36.7% of our cash outlay. Ford also pays a 0.20 quarterly dividend but we just missed January (18th) but seven more $200 payments is a bonus $1,400, which pumps our return up to 52.7%, that's 2.7% per month!
And, don't forget, in the worst case, you end up with 2,000 shares at $22,570, which is $11.285/share and then the 0.80 annual dividend is 7% alone and, of course, we'd sell 20 more calls (not puts unless you want 4,000 shares) for $1.80 ($3,600) and suddenly, you have 2,000 shares at net $9.485 collecting your 0.20 quarterly dividends - that's 2% per quarter on dividends alone
Now, there's a fancier way to play F and that's what we call an ARTIFICIAL buy/write where, instead of owning the stock (which pays a nice 4.85%, 0.80 dividend, we instead buy 10 2019 $10 ($2.98)/12 ($1.80) bull call spread for $1.18, selling the same $12 puts for $1.92. That gives you a net credit on the spread of 0.74 ($740) and we're only obligated to buy 1,000 shares for net $12 ($12,000) and you will get back $2,000 in the spread if F simply holds $12 into January 2019. The stock does not have to go up for you to make money!
On the downside, the worst that can happen is you end up owning 1,000 shares of F for net $11.26 - a 10% discount to the current price. Given we have such a nice position, we can still sell calls to make even more money. Since our cash outlay is a 0.74 credit and margin required is $1.44 per contract, our goal should be just to collect 10% per month of the 0.70 cash+margin we've committed to the trade - otherwise, we are engaging in the great sins of greed and over-leveraging
Looking to make 0.07 per month is easy. We can, for example, sell five March $13 calls for 0.15 ($75) and see how that goes before selling more. That's a very easy way to quickly generate 10% monthly returns while your upside risk doesn't kick in until F is over $13.15, well over the top of your spread (otherwise, you just roll your short calls along on months you don't collect the cash).
As a rule of thumb, if a stock isn't paying 3.5% or better dividend, there's no point in tying up the cash required to own it - so we'll prefer the artificial buy/write to the traditional but both are valid and both are very powerful long-term wealth creation tools that form the basis of our Long-Term Portfolio.
Here's a great list of
Top Dividend Stocks by Sector and Coke (NYSE:
KO) is on sale and pays a $1.40 (3.35%) dividend which, of course, we can enhance using our system.
- Buy six KO 2019 $35 calls for $7.50 ($4,500)
- Sell six KO 2019 $42 calls for $2.90 ($1,740)
- Sell four KO 2019 $38 puts for $2.85 ($1,140)
- Sell three KO April $42 calls for $0.67 ($201)
Our net entry here is just $1,419 on the $4,200 spread so the upside potential here is $2,781 (196%) plus whatever other short calls we sell along the way. The net ordinary margin on the short puts is $1,948 and, of course, we're obligated to own 400 shares of KO at $38 ($15,200) plus the $1,419 we lay out works out to an average of $41.55 if assigned so no discount but a much smaller assignment risk this way.
