Mar 192015
 

A couple days ago I made $220 in about 5 minutes from trading options. Today I will explain exactly what I did, why I did it, how others can do the same if they wish to, and the risks involved with this maneuver. Out of all the option trading strategies out there, buy write options are probably the least risky, especially done with underlying large cap, blue chip stocks. They also require minimal knowledge, no money down, and are accessible to the general public. 😀

So first, what the heck is a Buy Write options strategy? Simply put it’s when we buy a stock, and then write (sell) a covered call against the stock we just bought heh. 😉

The reason we might want to implement a buy-write is because we believe the stock will not move a lot in either direction in the near future and we want to generate some extra returns in the mean time!

Through a suggestion from a friend I decided to perform my first buy write strategy earlier this week. I chose to do it using the National Bank of Canada, which is one of the largest financial companies in the country with a strong balance sheet and growing profits. 🙂 Canadian banks are ideal for doing Buy Writes with because they are fairly stable and grow their dividends over time.

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So let’s quickly run through my thinking process. What is the purpose of buying a stock and then writing a call option against it? For me, it’s to make some quick and easy money with minimal risk, but a high chance to beat the market. 😀

So let’s go through the steps of my strategy. Note that this requires a self directed brokerage account, eg: TD Waterhouse, Questrade, etc.

How Buy Write Options Work

Step 1: I bought 100 shares of National Bank on the Toronto Stock Exchange for $45.71 each on Tuesday. This was very straight forward. I just bought it like I would any other stock. The total cost was $4,580.99 including commission.

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Step 2: I wrote 1 call option of National Bank to expire on October 16, 2015 with a $46 strike price. I chose $46 because it’s very close the current market price of the stock and writing “at the money” calls is usually the best choice for this strategy. This type of option writing is known as a “covered call,” because I have the underlying stocks to cover my position if the option is exercised, and the buyer calls away my 100 shares of NA. If I do not have any National Bank stocks then this would be known as a “naked call” in the world of option trading, which is more risky.

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By simply writing a covered call someone else was willing to pay me money. The income I received after commissions from this option trade was $220.76. 😀 Here’s a look at my 2 transactions in my brokerage account after everything is settled.

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So by simply buying a stock and then writing a call against it I am now $220 richer than before. 🙂 Not too shabby for doing some research into options trading and then spending 5 minutes to execute the trades online.

For a detailed tutorial of how to actually write a covered call you can see my previous Trican options post, which has step by step screenshots with markers and arrows for easy understanding.

So why would someone else be willing to pay me money to buy the option I wrote? Well when I write 1 call option for National Bank at $46, what I am essentially doing is telling the world that I will give anyone the option to buy 100 shares of National Bank from me at a future date for $46. In this real life example, the future date I chose is in October, which is 7 months away.

This means that if National Bank shares are trading higher in October then I would have to sell my 100 shares for $46 to the person who bought my call option, even though it’s below the market price of the day. If someone is bullish on NA stocks and think the share will rise then this is obviously a win for them. They don’t have to call away my shares of course. For instance if the price of NA shares drop by October, then they can just walk away and not exercise the contract. After all, why buy shares from me at $46 each, when the market is selling them at a lower price? 🙂 But of course the privilege to profit if the stock moves up, yet not risk losing anything if the stock goes down comes at a price for the option buyer. Otherwise it wouldn’t be fair. So to buy the call option I wrote, the buyer will have to pay a premium to me because I’m giving up potential gains in the future.

The following chart shows the potential outcomes of my buy-write options strategy once the option expires in October.

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The magenta line shows the profit or loss of someone who only bought NA shares and held onto them until October. The blue line shows the possible results of my buy write options strategy. The upside of a buy-write technique is capped at my premium of $220 basically. However it outperforms the long only method at every point below the cap. 🙂

Writing a covered call is a great way to maintain current market exposure to a stock while making some income, or to attempt to outperform the markets by doing a buy write if the stock price is not expected to move significantly in the near future.

The largest risk is if the stock drops very low by October and even though the option will expire without being exercised I will still be stuck with 100 shares of National Bank which is worth less than what I purchased them for. If that happens I will probably write another covered call against the shares again to try and get them called away while earning another premium in the process. 🙂 I will write a follow up blog post when this option contract expires later this year.

What I like about buy-writes in a margin account is that it doesn’t require any initial savings. Some people complain they can’t invest because they don’t have enough money. Thankfully buy-write strategies don’t require any money. The $220 I made on Tuesday did not cost me anything because I borrowed all the money to buy the stock in step 1 from the bank. TD Canadian margin rates for all its customers is currently 4.25%. Meanwhile National Bank stocks pay out 4.35% in annual dividends, so the dividend income can completely cover the cost of borrowing on margin. 😀

Disclaimer: Options and the stock market can be risky. Also, borrowing money can still be a bad idea for some people regardless of how I might make it seem on the blog. 😉

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Random Useless Fact

We have to admit our faults before we can improve upon them

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29 Comments on "Buy Write Options Trading Strategy"

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JC
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I like the buy-write strategy but I wouldnt use margin for it. I’m just not comfortable borrowing money to invest in stocks. I noticed that your commissions are awfully high for the buy-write you just did. Do the Canadian brokerages not offer a way to do the buy-write in one trade? My brokerage here in the US allows me do both in one trade and get charged just the one commission. That will help out with the income you can receive if you really pursue this strategy.

Roberta
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Roberta

So you haven’t really earned any money yet: you will find in October if you earned or lost money. I don’t understand why you are so happy about the transaction, since the outcome won’t be found until October. The right emotions to have are being both worried and hopeful. Why do you act as if you already won something? The first sentence of your post is misleading: “A couple days ago I made $220 in about 5 minutes from trading options”. No you haven’t made anything yet.

Chris
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Chris

Just curious about the tax implications of this. Do you just add this amount minus commissions to next year’s tax? My lazy butt would lose motivation if I had to keep track of this info numerous times per year for a relatively small amount of gain.

Anonymous
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Anonymous

So….Does this matter? In other words, if you believe in the stock markets, will you perform that much better to justify the risk and additional work?

PC
Guest
Did you account for the assignment fee at TDW of $43 when you did this CC trade? You didn’t mention that in your post. Once your covered call is called away, you will have to pay that fee. For me, I did a similar trade in my QT RRSP account (assignment fee is $20). I bought the stock at a higher price @ $48 and sold a covered call for $50 further out to Jan 2016 collecting a premium of $280. If NA.TO is trading above $50 by Jan 2016, my covered call will be assigned and I stand to profit $200 in capital gain and keep my premium of $260. $460/$4800 = 9.6% profit overall. If NA.TO is trading under $50 by Jan 2016, I keep my $280 premium and I can write another cover call against the stock for further income. It’s called milking the stock. Currently, NA.TO is trading at $46.61. I have a paper loss of $139, but I already collected $280 premium as a hedge. Am I losing in this trade yet? The answer would be a no. Great way to create income… makes you not fall in love with the stock.
Gen Y Finance Guy
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Covered Calls and Short Puts is something that should be in every investors tool box. They are really good portfolio enhancers. And in times of crisis premiums get fat and they offer good downside protection during a market decline. BTW, you can certainly get much better commissions. Most people don’t realize that the commission side of the equation is negotiable. I have my brokerage with TD Ameritrade and I pay $0.75/contract for options (with no minimums or fixed fee) and a penny per share for stock ($1 minimum). So your exact trade would had only cost me $1.75 to execute, where you spent almost $21.23. Also you can execute a buy write or covered call all in one trade order. You can do up to 4-legs in a single order. If you are with TD Ameritrade then I highly recommend that you check out the Think or Swim trading platform that they offer. Lastly, when you contact support at TD to ask for lower commission, leverage your consideration to move over to IB. I have used this in the past to help friends who are just starting out get lower commissions. The last friend I helped out got $1.50 commissions… Read more »
The Starving Artist Canada (@blerghhh)
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Gen Y guy: Commissions are NOT negotiable up here in Kanuckistan. (Canada). Plus, TD Ameritrade is not available to Canadians.

The best choice for low costs is Interactive brokers. Option prices are typically $0.75 or less per contract. (I’ve paid as low as 2-cents per contract) Assignment fees are $0. Yes ZERO. And it has much better access to Canadian markets as well as global markets.

Gen Y Finance Guy
Guest

Hmmm, I thought they were available in Canada. You would know better than me 🙂

I used IB in the past, but hated the platform. Until I negotiated my rates I would do all my analysis and what not on the Think or Swim Platform with TDA and then execute my trades on IB. But know I have the best of both worlds…except maybe the stock assignment fees of $0. But those are one-off events for me.

Cheers!

The Starving Artist Canada (@blerghhh)
Guest

TOS is by far the most beautiful platform, but the last I looked, you can’t trade on CDN exchanges.

Also, $0 assignments adds a whole new world of strategy for low volitility stocks you’re planning on accumulating. You can write a ladder of ITM calls against your stock to provided a great deal of downside protection and a whole lot of cost-basis reduction and/or freeing up capital to do something else with.

It’s an excellent strategy for us in our retirement accounts as the rules we have in place are even more restrictive than US IRA rules. We can’t short puts nor do any spreads in our retiremnet accounts.

Long stock
Long calls and Long puts
Covered calls

And that’s all we can do.

MU
Guest

It’s a good strategy. I also like to use it. I currently have a covered call with my CVX. The only disadvantage for this strategy is that you may have to sell this solid stock at $46 upon expiration, while the market price of this stock may be much higher.

Gen Y Finance Guy
Guest

80% of options expire worthless 🙂

The Starving Artist Canada (@blerghhh)
Guest

Another way of looking at this move is by viewing the premium as cash back. Your $46 call on a $46 stock where you collected $2 means you only paid $44 for the stock. (Lousy rounding is lousy). So your money at risk for owning the stock is $4400.

And as for will this work? It already has. You’ll get at least 1 dividend payment out of this if NA rises in price. You won’t have lost a cent (except to high assignment fees) if you get called away and the stock is $48. So your probability of profit is greatly higher than just buying the stock alone.

Covered calls is a proper way of reducing cost basis for your positions. (Dollar cost averaging is a fallacy.)

Gen Y Finance Guy
Guest

Its all about cost basis reduction and increasing your probability of profit.

The Starving Artist Canada (@blerghhh)
Guest

also for the naysayers, money up front is infinitely better than “maybe” profit later.

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BeSmartRich
Guest

Very interesting strategy and I will always have my eyes on until I understand it better. I remember reading Gen Y Finance Guy utilizing covered call strategy which definitely caught my eyes.

David
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David

Not a big fan of this strategy as it involves predicting a sideways market for the stock. Risking $4000 you don’t have to get 10% annualized, not the greatest risk/reward trade off! If you’re bullish enough on the stock to not worry about losing the $4000, why not buy the stock long or sell OTM calls?

I think this strategy is slightly better with index options.

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anonymousengineer555
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anonymousengineer555

So did you end it early or when it went to ~50$ did they execute the trade? and did you incur said 43$ charge?

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