Create Consistent Monthly Income
Today we’re going to walk through how to create consistent monthly income with stock options. We currently own 800 shares of MBUU in this portfolio and we’ve worked our basis down to $28.03 per share. With MBUU trading at $36.12 today we’re in a good position on this holding. We had two contracts of the $32.50 put, one covered call at $37.50 and another at the $40 strike. All four of those contracts expired out of the money on Friday. Here’s the post that walks through how we made those options trades.
Now we’re able to sell some more option contracts. MBUU only has monthly options, so we’re going to go with one month contracts for the 9/19 expiration date. Here’s a refresher on the basics of option contracts. We’re going to sell a cash secured put option below the current trading price. Each option contract is for 100 shares of the company. We’re looking at the $32.50 strike price. We need to have 100 x $32.50, or $3,250 available in our brokerage account. And we need that for each put option contract we sell to open. In this case we’re selling three contracts, so we need 300 x $3,250 or $9,750. Selling these contracts help us create consistent monthly income.
When we sell to open a put option we’re locking up our capital for the duration of the contract. If the trading price of MBUU falls below $32.50 per share the contract buyer could assign the shares to us at any point up until expiration. If MBUU is trading below $32.50 at expiration then we will be put the shares at expiration. That’s about one month from now. Since we’re tying up our capital for a month, we want to be sure we getting a solid return for the duration of the contract. We aim for at least a 20% annualized return on our capital and create consistent monthly income. We want that number to be higher than what we would get on a bond or in a savings account. Here are the steps we take to determine that.
We start with the duration of the contract. This trade lasts for one month, and there are twelve months in a year. That makes our time multiplier 12. Then we look at our capital. The strike price is $32.50 and the premium per share is $0.80. So we divide the $0.80 in option premium by the $32.50 strike price and we get 0.025. Then we multiply the capital component by the time component and we get 0.025 x 12, which is 0.295. That’s an annualized return of 29.5%. And we’re only selling to open a put option contract on a company we want to own at the strike price. So we’re getting a nearly 30% annualized return to promise to buy a company we want to buy, at the price we want to buy it. That works for us. Here’s the Option Contract Return Calculator we use.
Now that we have cash secured put options below the money, we’re going focus on the other side. With MBUU trading at $36.12 we’re going to sell covered calls at the next two higher strike prices. We’ll sell one contract at the $37.50 strike and two more at the $40 strike. That gives us three covered calls, which represents 300 shares. Since we own 800 shares right now we could end up selling 300 shares if MBUU runs up through both of our strikes and we do not adjust either of these positions. If MBUU stays go above $37.50 but stays below $40 we’ll be obligated to sell 100 shares at the $37.50 strike, but we’ll keep the other 200 shares. If MBUU stays below $37.50 we’ll keep our entire position. We’re only selling three contracts of covered calls in case MBUU runs up through both of our strikes.
We sold to open one contract of the covered call at the $37.50 strike price for $1.40 per share in premium. We also sold to open two contracts of the $40 strike for $0.65 per share. That nets us a total of $2.70 on the covered calls. We also brought in $2.40 on the cash secured put option contracts. Selling puts below the money and covered calls above the money helps us create consistent monthly income. We generate that passive income by making some promises. We promise to buy shares of a company we want to buy, at the price we want to buy it. Then we promise to sell some of those shares for a price that’s higher than our cost basis. And we get paid to make those promises.
Monthly Trade Recap
We sold to open three contracts of the $32.50 cash secured put option for the 9/19 expiration date. That trade gave us $0.80 per share, or a total of $240. Then we sold to open one contract of the $37.50 covered call for $1.40 in option premium. We also sold to open two contracts of the $40 covered call for $0.65 in option premium per contract. That gave us a total of $270 for all of the covered calls combined. These trades reduce our cost basis on MBUU down to $27.39 per share and create consistent monthly income as we generate cash flow. With MBUU trading at $36.23 per share today, we’re happy with our position. Here are some of our other recent trades.
