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Thursday, June 23, 2011

Some simple trades on call options

I just attended a simple talk by Terence Tan on stock options in US which can help us earn regular income. Summary of the strategy:
  • Own a good and stable stock
  • Sell a call option of the stock (One call option only for 100 shares of the stock) and pocket the money from sales of call option.
Assumptions: 
  • Historically, 90% of the options do not get exercised. Meaning 90% of the buyers of call options would let them expire and lose the money. Thus, why not we sell call options and pocket the money 90% of the time? 
What are the risks? 
  • If the stock price rises much higher than exercise price, highly likely the call option will be exercised and you are forced to sell at the exercise price. In other words, you don't get to profit from the upside of the stock price beyond your exercise price. But hey, you've already pocketed the money from selling the call option, so you're still profiting. 
  • If the stock price remains the same as exercise price, the buyer of call options would likely not exercise, taking into account the transaction costs involved. You still pocket the money from call options sale and you're holding the stock.
  • If the stock price falls, the call option is worthless and will not be exercised. You still pocket the money from call options sale and you're holding the stock. 
If you trade this repeatedly, the cash you receive from selling call option could help you buy more stocks and in turn enable you to sell more call options. It's just like buying properties and renting them out, the rental income you've got help you to own more properties and increase your rental income. 

But of course, the catch is that your stock must be good and won't go bust anytime :P Eg. Exxonmobil, GlaxosmithKline, Microsoft etc.

I've yet to explore this kind of trades so I can't judge how effective it is. You could try this through Optionsxpress or stockoptions in Singapore.

9 comments:

  1. Ya, but have to buy more than 100 stocks. For instance Microsoft is trading at $24.63 and the July Call Option at $24 strike is 0.86 and $25 strike is 0.28 - so if just buy 100 stocks, cannot make any money as most if not all of the profits will go to commission.

    I suppose this is another game where got money make money, no money then very sorry.

    Also, have to worry about the fluctuation of US/RM currency.

    What's your view?

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  2. Ya. True. This one the more capital we start with, the better and faster our earnings will be and of course we have to take into account the commissions involved. ASX is another market we could try this one out. As I've said in the post, I've yet to try it thus it will be hard for me to evaluate how good this strategy will be. Maybe you could inform me if you're successful in this :)

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  3. ASX got options trading ah?

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  4. Yup. You could check out their website. http://www.asx.com.au/products/equity-options.htm.

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  5. Koay, which platform are you using for ASX trades? Got online trades or not? thanks.

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  6. Thus far I have yet to come across any platform in Malaysia offering online trading in ASX. We could only place our orders by phone/sms/email to our remisiers/dealers, not through online. If you come across any, do share with me as well :)

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  7. In financial market, there is no such thing as free lunch. How one invest or punt depend on what you think the asset is going to perform in the future. People buy shares with the hope that the share price will go up fast, Why then you want to sell a call option on the particular shares, for a small premium, but will cap the upside potential of those shares? If one thinks that share is going to go down, is it worth to earn that premium on your covered call option? I might as well sell the share now so not to lose so much in the future. Why not in the earlier case buy a call and a put in the later case? One will make money on the premium if the market is going to be flat before the expiry on the option writing, but then you can do financial engineering like straddles, butterfly and condor etc with options. The cost of play will be much lower than selling covered options. How much money a small time investor has to write covered calls?

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  8. Thanks a lot for your advice, KC :) I guess this strategy would be more appropriate for less sophisticated investors who would have little time in monitoring and forecasting the markets and buying/selling shares within a few days or weeks or even months wouldn't be in their vocabulary.

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