Buying and selling options can drastically increase your portfolio’s consistent return. Generally options are seen as conservative, but I’m here to tell you that you can easily achieve double digit yearly returns with options.
Since my recent update about my personal portfolio, I have taken a giant hit on my amazon option. This position was not conservative to say the least and Amazon went down about $20 a share in after-hours after earnings reports. Surprisingly even after all the pain I am still up about $120 for the year, which would equate to 26% APR return. Now after hearing that you might think – why would I even take a conservative position with options if yo are clocking 26% APR? Well I might have finished up 2% for the month of January, but at one point I was up more like 18% – Fluctuations can be too sharp of adjustments.
So I restructured my portfolio to take a little more conservative of an approach with a large portion of my portfolio. it first started with me purchasing 100 shares od DOW chemical at $34.12 a share. I then wrote and sold an option with an expiration of 9/22/12 @ a strike price $35 for a premium of $2.60.
What does this all mean?
I own 100 shares of DOW and have given someone the right to buy the shares from me for a price of $35. They have the option to buy them from me until 9/22/12 (231 days from now).
Why DOW Chemical?
Dow Chemical is a relative conservative stock. I feel that the stock is more likely to go up than down, but honestly I really don’t care if it appreciates at all. The goal here is that it does not depreciate. I also considered GE, but the options were not paying as well. Another reason – Dividends. Dow pays 2.93% Dividend Yield, so if I do end up holding onto the stock (which is very possible), I will enjoy a relatively healthy dividend payout.
What am I netting from this Transaction?
If Dow Chemical Appreciates to $35 or more and the option is executed, I will receive: $260 (option selling price) + $82 [$35 (strike price)– $34.12 (price paid) * 100 shares] + any dividends I receive before the execution of the option. But the general idea is I’ll receive $348 on my $3,412 investment (ignoring commissions). That equates to a 10.2% return. If the option is executed on the strike day (231 days from now) that is 16.1% APR (not compounded). If the option is executed earlier than that – it could be even higher of an APR.
If Dow Chemical Depreciates below $34.12 and the option is not executed, I will net: $260 (option selling price) + any dividends received – [(100 shares x current market price) – (100 shares x 34.12)]. It is also important to note that as the price devalues, I can buy back my option for a fraction of the cost and re-write the option to net another premium. My APR will vary from 14.93% + dividends to –92.4% (if the stock completely defaults). My break-even price not considering dividends is: $34.12 – $2.60 = $31.52 a share.
If Dow Chemical doesn’t change in price at all I will net: $260 + dividends received. APR: 260 / 3412 = 7.6% * 365 / 231 = 12% APR + 2.93% Dividends = 14.93% APR.
So there you have it – Why options can be an attractive approach to achieving double digit returns. I will be back with more posts on how to analyze options and how the process of buying back written options to retain a higher APR even in a declining market.