Option Trading for Income

We’re option trading for income, and today we’re walking through our UPS position. We currently own 400 shares of UPS with a basis of $92.35 per share. We were just assigned another 100 shares of UPS on Friday at the $85 strike. That trade was out of the money with UPS trading above $85 until Trump’s announcement of 100% tariffs on China. Trump’s announcement tanked the market on Friday and that put UPS below our $85 put option strike price at expiration. That gave us the shares at $85. Then over the weekend Trump walked back his tariff comment, and today markets are recovering some of the losses. But not all of the losses stemming from Trump’s comments.  Here is our most recent post on our UPS trades.

We have room for about $60,000 of UPS in this portfolio. We currently have an allocation of about $37,000 to UPS. So we’re over halfway to a fully loaded position. Now we’re going to sell to open a covered call option on the shares we just bought at $85. When we sold to open the $85 put option we brought in $0.84 in option premium as passive income. That means our effective assignment price on those shares is the $85 strike minus the $0.84 in option premium, or $84.16 per share. As long as we sell our covered call above that basis we’ll make money on the trade, even if our shares are called away.

We sold to open the $85 call for the 10/17 expiration date for $0.56. That brings our cost basis on that tranche down from $84.16 to $83.60 per share. If UPS continues trading below our $85 strike price from now through expiration our covered call will expire worthless out of the money. In the event UPS trades above $85 and we sell our shares we’ll profit $1.40 per share. We would sell the shares at $85 and our effective basis on these shares is $83.60.  Since we have 400 shares of UPS right now we’re ok with continuing to sell calls at our assignment strike until our shares are called away. Since we’re option trading for income we’ll use that option premium for cash flow.

We’re also going to sell to open another cash secured put option. On the price chart below we can see a floor forming around $82 for UPS over the last month or so. We’re going to sell a put option right at that $82 low. We’re happy to take more shares of UPS in that price range. If the floor holds we’ll just collect the option premium and sell another put option next week.

When we sell to open a put option we’re making a promise to buy 100 shares of UPS at the strike price. In this case, it’s the $82 strike. So we’ll need to have at least 100 times that available in our brokerage account to sell the contract. That’s $8,200, and that capital is tied up until the contract expires. When we do option trading for income we want to be sure we’re generating an acceptable level of return on that capital while we wait for the contract to run its course. So we do some simple math to help us determine that.

The first thing we do is determine how many times we could do a trade of a similar duration over the course of a year. In this case, the trade lasts for one trading week. There are 52 weeks in a year, so our time multiplier is 52. Then we look at the option premium as it compares with the strike price. We’re bringing in $0.61 for selling to open the put option. We divide that premium into the $82 strike price, and we get 0.0074. Then we multiply that by our time multiplier of 52 and we get 0.387. That’s an annualized return of 38.7%. Here’s the option contract return calculator tool we use to do that.   When option trading for income we target an annualized return of 20%+ on our capital.

Weekly Option Trade Recap

We were assigned 100 shares of UPS on Friday at the $85 strike. When we factor the option premium we took in when we sold to open the contract our cost basis on those shares is $84.16. Then we sold to open a covered call for the $85 strike on the 10/17 expiration date for $0.56. So the option premium on those 100 shares brings our cost basis to $83.60. If UPS trades above $85 and we sell our shares we’ll still net a gain of $1.40 per share. If UPS continues trading below $85 our call option will expire and we’ll sell another one next week. We also sold to open the $82 put option for the 10/17 expiration date for $0.61 per share.