Profitable Options Strategy
Our profitable options strategy is to sell a cash secured put option just below the trading price. We keep that premium, and if the underlying company continues to trade above the strike price the put option will expire worthless out of the money. Then we sell another put just below the money and collect more premium. Each time we do this we build some equity in the company before we own shares. Eventually we get assigned some shares at our strike price, and by the time this happens we’ve built some equity in the position. Now that we have some shares, we’re going to sell covered calls on part of the position to generate some more passive income. We are only selling covered calls on a portion of our holding so we can capture the gain when the company goes back up to where it was trading earlier.
Today we’re going to walk through the profitable options strategy we’ve been using to generate passive income. We had 600 shares of MBUU in this portfolio with a basis of $30.02 per share. We had two contracts of covered calls at the $37.50 strike that expired Friday, 3/21. Then we also had two put option contracts at the $35 strike price and another two at the $30 strike. MBUU closed trading at $29.55 on Friday, so our calls at the $37.50 strike expired worthless. Our puts at $35 and $30 were assigned. That brings our position on MBUU to 1,000 shares with a basis of $30.53 per share. We sold to open two put option contracts on 3/20 for the 5/16 expiration at the $27.50 strike. Now we’re going to sell covered calls on the shares we just bought at $30 and $35.
Since our current basis on MBUU is $30.53 per share, we’re going to sell calls at $32.50 and $35. We’ll collect options premium as passive income on both of the trades. If MBUU runs up through our strike prices our shares will be called away unless we adjust the position. Since we’re selling the covered calls above our cost basis we’ll make money on the sale of the shares in addition to the option premium.
Since MBUU is a relatively low volume security it only has monthly option contracts. So our choice is to sell the covered calls for the 4/17 expiration date or the 5/16 expiration date. The $35 strike on 4/17 has a Bid of $0.15 and an Ask of $0.25. It’s likely that we could fill that contract for $0.20. That’s not great. The same $35 strike on 5/16 has a Bid of $0.55 and an Ask of $0.95. It’s likely we can fill that contract for about $0.70. Would we rather make $0.20 over one month or $0.70 over two months? $0.70 over two months equates to $0.35 per month. Since this is nearly double the premium for the one month contract we need to dig a little to figure out why.
MBUU has their earnings release on 5/1. If we sell to open the covered call for the 5/16 expiration date we’ll be going right through earnings. Here is where we find that information. If we only had 100 shares of MBUU we would not sell the covered call through the earnings release. But in this situation, we own 1,000 shares and our basis is $30.53 per share. Our intent by selling this covered call is to generate some cash flow and reduce our basis. We could do nothing and wait for the market to reprice MBUU. Or we could sell some option contracts for passive income to reduce our basis while we wait for the market to catch up. This profitable options strategy gives us a more active approach.
We also need to think about the number of covered call option contracts we want to sell. Since our intent is to generate cash flow we’re going to sell to open covered calls that are closer to the money. But we’re only going to sell these on a port of our position. We’re also going to use different strike prices. If MBUU runs up through the $32.50 strike we’ll still have our shares for the $35 strike as well as our unencumbered shares. We can also buy to close the call options and roll them to a different strike that is further out in time.
Weekly Trade Recap
Our profitable options strategy was to sell to open a covered call at the $32.50 strike for the 4/17 expiration date. We brought in $0.55 in passive income per contract with that trade. Then we sold to open the $35 covered call for the 5/16 expiration date. We brought in $0.65 in passive income per contract on that trade. We did two contracts of each trade. If MBUU runs up through our strikes we’ll still have 600 shares of MBUU. We’ll also have a significantly reduce basis after collecting the additional premium and the gain on the sale of the shares. As it stands right now, we’ve worked our basis on MBUU down to $30.29 per share.
