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.
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.
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.
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.
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.
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. 😉
Random Useless Fact
We have to admit our faults before we can improve upon them