Simple Options Trading Example

Today we’re walking through a simple options trading example. We’ve been using OXY to generate passive income trading stock options. We currently own 800 shares of OXY in this portfolio. Using stock options premium and dividends we’ve worked our basis down to $49.99 per share. OXY goes ex-dividend today, 3/10. Our most recent post on OXY was ‘Using Options Premium for Cash Flow’, and you can read it here. Now we’re going to do another easy options trade to generate passive income.

With our basis on OXY at $49.99 we can sell a covered call at the $50 strike or higher.  If OXY runs up through our strike we will be obligated to sell those shares at $50. We like OXY’s long term potential, but we’re also concerned with the bluster and uncertainty coming from Washington recently. So we’re going to be more aggressive selling covered calls for passive income. We’re ok if we have part of our position called away here. This passive income strategy for accredited investors will also give us premium when we sell to open the option contracts.   

Weekly Options Trade

Today we sold to open the $50 covered call strike for the 3/21 expiration date. We currently hold 800 shares, and we sold to open four contracts. Each contract covers 100 shares. If OXY runs up through $50 we’ll be obligated to sell 400 shares at our $50 strike price. We will have the choice to either let those shares go or roll the position to a different strike price that is further out in time. This simple options trading example brought in $0.40 per share on each contract for a total of $160. We’ll keep that premium regardless of what happens with our shares.

We also sold to open the $44 put option, also for the 3/21 expiration date. The premium was $0.37. When we sell to open a cash secured put option we’re making a promise to buy 100 shares of the underlying company at the option strike price. In this case that’s $44. So we’ll need to have $4,400 available in our account for each contract we enter.

We want to be sure we’re generating a strong annualized return when we sell a put option. We’re obligating $4,400 on this short term investment, and that $4,400 is generating $37 over the course of the contract. This trade is open for 11 days. Now we want to determine our annualized return on our capital. Since this trade is 11 days long we divide the days in a year (365) by 11 (the duration of the contract). That gives us 33. So our time multiplier is 33.

Then we divide our passive income for selling the option contract ($0.37) into the strike price ($44). That gives us 0.0084. Then we multiply that by our time multiplier (33) and we get 0.277. This simple options trade example has an annualized return of 27.7%. That’s good enough for us!

Weekly Trade Recap

We currently own 800 shares of OXY and we just collected the $0.24 dividend. Today we sold 4 covered call option contracts at the $50 strike. We collected $0.40 per share selling to open the call options. We also sold to open the $44 put option for $0.37. All of the contracts share the same 3/21 expiration date. This method for generating passive income selling stock options has reduced our basis down to $49.74 per share.