Thoughts on Options, and 9 Recent Trades

I have never been a big fan of options trades, but I changed my mind after reading blogs of fellow dividend bloggers such as Divgro. I now believe that selling, or writing, options can be a good way to supplement one's income, since much of the value of options derives from their time value, which decays over time to zero at expiration. As a quick overview, here are four possible trades with options:


1. Buy call options: this is a bullish bet that a security (usually a stock) will rise above a given price within a given time frame. Buying out-of-the-money calls for pennies per share can be lucrative, easily multiplying one's investment many times over if one is right about the direction of the stock going up. But if one is wrong, the option expires worthless and one has lost 100% of the initial investment. Since the vast majority of options expire worthless, this is a high-risk, high-reward strategy. Options on more volatile stocks naturally cost more to buy. For example, volatile NFLX is currently trading at $221, and if I were to bet on it surpassing $250 in a year, I could buy a call option with $250 strike expiring 20190118 for $24.15 per share, or $2415 per contract (since each contract is 100 shares). That means NFLX has to go above $274.15 within the year for a 24% gain to show a profit; of course, if NFLX goes to $300 within a year, the price of the option would reach $50 for a 100%+ return, and if it were to go to $350, the price of the option would reach $100 for a 300%+ return. At this time, I don't find the price worth the gamble.

2. Sell call options: On the flip side, one could capture the time decay by selling call options. This is a bearish bet that the stock would not reach a given price within a given time frame. Selling covered call options essentially caps gains at a fixed price. The stock market has an upward bias, and bearish bets rarely pay off, and often enough one gives up a lot of potential gains for a lousy premium. For that reason, I am loathe to sell call options on stocks I would hold forever. True, you could avoid option assignment by buying back the option at a loss, but the potential loss is virtually unlimited while the gain is limited to the option premium received. This is why one should almost never write uncovered call options because there is no limit to how high a stock could go, and therefore no limit to how much you can lose if you must buy back the call option at any price. With covered call options, you could at least allow option assignment to call your stock away. I would sell out-of-the-money call options on stocks that I would not mind selling today at the strike price anyway. That gives me two ways to win: the stock may never reach the strike price within the option duration and I secure the premium income (best case scenario), or if it does, I was happy to sell the stock anyway (some consolation, as if I had simply sold the stock early). I would also sell call options on leveraged inverse ETFs that I would sell short today at the strike price anyway, and keep my fingers crossed that no big bear market happen during the option duration.

3. Buy put options: this is a bearish bet that a stock will fall below a given price within a given time frame. Some use this as an insurance on stocks in one's portfolio in case of a bear market, but it is an expensive insurance. I might do this to make bearish bets on stocks I loathe, because my potential loss is capped by the premium I pay, unlike shorting stocks which could entail unlimited losses. However, most of the stocks I loathe, such as NFLX, are volatile and therefore cost a lot of option premium to buy. For example, if I want to bet on NFLX dropping below $200 within a year, I would have to pay $2165. If NFLX drops to only $201, I lose. If NFLX drops below $200 but takes longer than a year to do so, I lose again. At this time, I don't find the price worth the gamble.

4. Sell put options: On the flip side, one could capture the time decay by selling put options. Of all four ways to trade options, this is by far my favorite. If I am willing to buy and hold a stock forever at the current price, I am more than willing to get pay a premium to commit to buy a stock at a discount price within a given time frame. With a cash account, one big disadvantage is that selling put options requires holding cash to secure the option, which can cause a lot of cash drag. But with a margin account at 15% portfolio margin at Interactive Brokers, cash drag is a non-issue. Selling put options is bad if the stock keeps falling well below the option price, but if I would never sell a stock anyway, that is a non-issue. It is therefore important to sell put options only on high-quality stocks that one is willing to buy and hold forever.

With that said, below are 9 options trades, all sales, I made recently. This is in a table format that I will henceforth report monthly.

ID	Action	Type	No.	Security	T. Date	Exp Date	Days	Days left	Strike	C. Price	T. Price Open	Comm. /Fees Open	Cost basis	Exp. Ratio	C. Price	C. Value	Unreal. P/L	Intrinsic Value	Time Value	Status	Short Put Commit	T. Price Close	Comm. /Fees Close	Price at Exp	Assign Implied Loss	Total Expenses	Total Income	Secured Income
												(14.92)	(2,014.08)	0.74%		(2,066.00)	(51.92)				21,900.00
1	S	C	1	AN	1/12/2018	2/16/2018	35	31	65	57.24	0.25	(1.09)	(23.91)	4.56%	0.16	(16.00)	7.91	(7.76)	7.92	Open	0						23.91	0
2	S	C	1	ATGE	1/12/2018	2/16/2018	35	31	50	46.35	1.09	(0.30)	(108.70)	0.28%	1.03	(103.00)	5.70	(3.65)	4.68	Open	0						132.61	0
3	S	P	3	MAT	1/12/2018	2/23/2018	42	38	13	15.12	0.41	(4.93)	(118.07)	4.18%	0.45	(135.00)	(16.93)	(2.12)	2.57	Open	3900						250.68	0
4	S	C	3	SQQQ	1/12/2018	2/16/2018	35	31	21	18.39	0.34	(4.93)	(97.07)	5.08%	0.34	(102.00)	(4.93)	(2.61)	2.95	Open	0						347.75	0
5	S	C	1	TZA	1/12/2018	3/16/2018	63	59	11	11.41	0.74	(1.10)	(72.90)	1.51%	0.88	(88.00)	(15.10)	0.41	0.47	Open	0						420.65	0
6	S	C	1	EXC	1/16/2018	4/20/2018	94	94	40	38.47	0.7	(0.30)	(69.70)	0.43%	0.7	(70.00)	(0.30)	(1.53)	2.23	Open	0						490.35	0
7	S	P	1	AAP	1/16/2018	1/17/2020	731	731	90	113.9	10.8	(0.37)	(1,079.63)	0.03%	11	(1,100.00)	(20.37)	(23.90)	34.90	Open	9000						1,569.98	0
8	S	P	1	CELG	1/16/2018	9/21/2018	248	248	90	104.82	3.6	(0.80)	(359.20)	0.22%	3.71	(371.00)	(11.80)	(14.82)	18.53	Open	9000						1,929.18	0
9	S	C	1	WMT	1/16/2018	2/23/2018	38	38	108	100.69	0.86	(1.10)	(84.90)	1.30%	0.81	(81.00)	3.90	(7.31)	8.12	Open	0						2,014.08	0

Trade #1: Sold call option on AN strike 65 exp 02/16/18 for $23.91 income after fees.

AN had a big run since July and should probably take a breather. At around $58 when I sold the option with strike 65, it would need another 12% gain within a month to get into the money, which I deemed highly unlikely. I would figure at least 90% of the time I will get to secure this income. In retrospect, however, this trade was a mistake, because $23.91 is too puny a premium to risk having my stock called away. Also, at a quoted option price of 0.25, the commission took up 4.56% of the cost basis, which is too much. I'd like to limit the expense ratio to 1% or less in the future.

Trade #2: Sold call option on ATGE strike 50 exp 02/16/18 for $108.70 income after fees.

Similar logic as the above trade, I figured ATGE had a huge run already and it is hard to reach $50, a 9% gain, within a month. Expense ratio is much better here at only 0.28%. The $108.70 premium is adequate to compensate for the small risk of having the stock called away.

Trade #3: Sold 3 put option on MAT strike 13 exp 02/23/18 for $118.07 income after fees.

I had sold out my MAT position at $13.20 back in November to harvest tax losses and regretted it after it immediately bounced to $18 due to speculation that Hasbro might acquire it. I never got a chance to buy it back after a month at below the price I sold it. This option trade gives me a second chance to buy it back below which I sold it. If this option gets assigned, my effective cost basis would be $12.61, a pretty good result. And if not? I get to secure the premium income! Win-win either case. Only bad thing about this trade is that the expense ratio was a bit high at 4.18%. I should have been able to reduce the expense ratio and increase my income by selling put for a longer duration. Lesson learned.

Trade #4: Sold 3 call option on SQQQ strike 21 exp 02/16/18 for $97.07 income after fees.

SQQQ is a 3x inverse ETF on the Nasdaq which will eventually go to zero. I had done well shorting this and similar 3x inverse ETFs. Barring an imminent bear market, SQQQ is extremely unlikely to reach $21 within a month. Also, I would not mind shorting 300 SQQQ at $21 today, when it is trading at $18, and would hold onto to it, so why not commit to it via an option? The trade was a mistake though, because the expense ratio of 5.08% was too high. As with Trade #3, I should have prolonged the duration and earn more from the time decay. Again, lesson learned.

Trade #5: Sold call option on TZA strike 11 exp 03/16/18 for $72.90 income after fees.

Unlike the other trades above, I sold this option near the money rather than out-of-the-money, because I could not get much income from selling out of the money. That is probably a mistake, because it increases the risk of assignment. Nonetheless, I figured the bull market will go on at least another month or two, and the leveraged inverse ETF will decay in value well below $11 after 2 months.

Trade #6: Sold call option on EXC strike 40 exp 04/20/18 for $69.70 income after fees.

EXC has been a poor investment for me. I bought these shares at $40 in 2012 and it is still below cost. The dividend income lessened the sting, and I did average down in my DSP account elsewhere, but still I feel it is better if I unburden my portfolio by reducing it. The $40 strike is close to the current price so risk of assignment is high, but that's ok with me. Its dividend yield of 3.4% is too high so selling it will lessen my tax liability. I need to reduce my EXC position. If I don't get assigned, I will keep selling call options on it until I do get assigned.

Trade #7: Sold put option on AAP strike 90 exp 01/17/20 for $1,079.63 income after fees.

I wished I could buy AAP at $90 today and would be willing to hold onto it for a long time. The current price is a bit much for me. By committing to buy 100 AAP at $90 for 2 years, I get paid $1,079.63, which is pretty good deal. If I do get assigned, the adjusted cost basis would be $79.20, which is amazing. And if I don't get assigned, I can't complain about securing $1,079.63 income. This might be my best options trade yet.

Trade #8: Sold put option on CELG strike 90 exp 09/21/18 for $359.20 income after fees.

I would love to buy CELG today at $90, but the stock tends not to stay below $100 for too long. I didn't want to stretch the duration much longer though, because the valuation is still a bit rich and if the stock were to continue to fall, it could easily fall well below $90. If that happens, I will likely sell another put option on the stock.

Trade #9: Sold call option on WMT strike 108 exp 02/23/18 for $84.90 income after fees.

WMT had a great year already and should take a breather. It is unlikely to go to $108 within a month. But if it did, I might as well get assigned and take some money off the table because I don't really see much growth in this giant retailer.

Summary: I sold 6 call and 3 put options in the last 2 days, for a total of $2,014.08 income, none of which is secured yet since all are open. Some lessons learned:
1. Keep expenses low. Since commission per contract can cost about $1, don't sell options for less than $100 income.
2. Prolong duration for sales of put options on high quality stocks.
3. Sell covered call options on richly valued stocks that I would be glad to sell anyway.
4. Sell call options on 3x inverse ETFs when stock market falls.
5. Sell put options or even buy call options when stocks I like to buy become cheap.

I am still new to this options game and have a lot to learn. What do you think? Any suggestions?