May 072014
 

I recently wrote about wanting to try options trading. There are different kinds of options. The strategy I’m explaining today involves selling an uncovered put option. Earlier this morning I submitted an order to sell one $0.60 put option for Teck Resources.

14-05-tckoptions

Unlike stocks, options have an expiration date so we can’t hold them forever. My TCK options contract ends on June 21st so I’ll post an update next month. But from now until then 1 of 2 results will happen.

Scenario 1- TCK.B shares increase in value so the contract expires. I keep the $48 premium with no strings attached
Scenario 2- TCK.B shares fall below $23/share. The contract is exercised and I’m forced to purchase 100 shares.

The first scenario would be ideal because I basically walk away with free money, yay! The second scenario isn’t bad either. Buying TCK.B at $23 is still 6% cheaper than today’s market price anyway. The P/E ratio would be about 14 x which isn’t a bad deal for a mining giant. I’ll just borrow $2,300 from the bank to buy the 100 shares. The dividend yield is higher than the cost of my margin loan anyway so it will be self sufficient. In other words, there is no outcome where I won’t be happy 🙂 The only possible risk is having to purchase TCK.B at $23 if the market value at the time could be lower, but that’s a gamble I’m willing to take 😉

Last Thursday I explained how a put option is kind of like a short term insurance policy against a stock correction. Below is a more detailed explanation of how it works.

Teck Resources (TCK.B) is trading at $24.5 CAD today. If a shareholder doesn’t want to risk his shares dropping below $23/share he can buy a put option with a strike price of $23, for a certain amount of time, for example until June 21st. This means that from now until the expiration date of June 21st, he has the “option” to sell his stocks for exactly $23/share to someone.

So if TCK.B falls to $10/share sometime before June 21st, he can sell his stocks for $23/share if he wants to get out. Of course if the stock price never falls below $23/share then his insurance policy expires. Technically he can still exercise his options contract even if the stock price goes higher, but there’s no point to sell his stocks for $23/share when he can sell them on the open market for a higher price. So by purchasing a put option he benefits from all the upside if the underlying stock goes up, but limits any potential losses if the stock falls.

It’s like buying short term car insurance. If something bad happens to the car then you can claim your insurance and be covered from any major loss 🙂 But if nothing happens or if your car’s resale value goes up, then the insurance policy will simply expire eventually. The only cost to you is the insurance premium you paid up front.

Whenever there’s a buyer in the market, there has to be a seller. So this is where I come in 🙂 I want to insure 100 shares of someone’s TCK.B at the strike price of $23/share, until June 21st. And the premium they pay for their insurance policy would go to me. This is my first time trading options so there could be some surprises along the way and I’m not sure if I know what I’m doing, but we’ll see how it goes 🙂

Disclaimer: I already own 60 shares of TCK.B

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Random Useless Fact: Light travels faster than sound. That’s why some people appear bright until they speak.

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PC
PC
05/07/2014 12:11 pm

I played with options before but I didn’t do too well and haven’t gone back into it. Maybe I’ll learn a few tips from you 🙂 and gain more confidence to go back at it again. I think I did call options. Good luck with your first trade 🙂

Phil
05/07/2014 12:33 pm

Good luck! A thought on options trading, but how might taxes be affected? If you win that’s fine pay tax at your tax rate I guess, but how do losses work, and I guess the 30 day trade suspension for that particular stock to claim capital loss. I’m not sure if there are any real tax issues, just thinking out loud. – Cheers.

TheMadInvestor
TheMadInvestor
05/07/2014 12:57 pm

Guy really? 14x P/E for a mining company?

TheMadInvestor
TheMadInvestor
05/08/2014 3:05 pm

Yea and it also includes in Dec 2010 when their P/E was at 38x……

Investing Pursuits
05/07/2014 2:56 pm

Welcome to options trading…. I never tried selling naked puts. I did covered calls before and bought options before.. I am not sure about this, but I will PUT is out there…, “when you sell a naked put, if your put gets called I believe the premium is subtracted from your ACB. ACB of put = strike price*100 shares * # of contracts + commission of the option for being excercised – (ootion premium – commission of selling the put)..

S Arun
05/07/2014 4:11 pm

Good luck Liquid, glad to see that you finally in action. Now, I kind of understand about option trading. Your explanations and examples are much easier to learn than from books.

TSML
TSML
05/07/2014 8:18 pm

I’m fairly confident I will never buy anything but a stake in a business at an attractive price. I feel like with all the other exotic markets options, they are merely a zero sum game with no particular benefit except for the winner of the zero sum game. The only real winners are the brokerages that get to charge for every transaction 😀

Marie @ 724 Credit
05/08/2014 1:37 am

Good luck to your new options trading! I can’t wait to read your updates about this one!

Gareth @ Investment Road to Freedom

Nice trade Liquid. My strategy is to do cash secured puts on dividend paying stocks I want to do. Come expiration I either decide to accept shares or roll them out/up or just repeat if they expire worthless. Then once I feel I have made enough premium I decide I want to keep the shares I then do covered calls on them to earn the dividend and the extra covered call income. The key with option trades is to work out your plan BEFORE the trade. That way if it goes against you the emotion has already been taken out and just follow your plan/recovery/exit strategy.