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