The Stock Option Writer
© Warren Kaplan 2011-2015
October 27, 2015
When you write a stock option, you are acting like an insurance company. That means you are giving the buyer a guarantee. You are guaranteeing them that they can buy your shares at a set price for a set period of time. Going the other way, you can be guaranteeing them that they can sell you their shares at a set price for a set period of time. For either of these guarantees, they pay you an upfront fee known as the premium.
When writing an option, there are a number of factors to consider. You have to be very mathematically inclined. You have to expect black swan events and you have to know what you are doing and why. Sure you want to make money but why? The word money needs to be translated into a number in order to understand if you are right or not. You can write an option for an annualized rate of 2% or for 40%. Both have an element of risk, which varies but first let’s look at the risk. You might write a call option at what you consider an impossible price for the stock to be called away from you but it really does happen. There was a point of time whereby I felt that if I sold certain shares of a company at a certain price and within a certain period of time, I would be very happy. I can tell you that from emotional experience point of view that sometimes I sorely regret having sold a call option as I hate to lose the stock at the original price that I had wished to sell the stock. There are ways to keep the stock, which is then selling at the higher price and reselling another call option at a still higher price. The method to use is called “buy/write” and it gets a nip complicated. You can find out more about buy/writes in the Michael Sincere book, “Understanding Options”.
One of the many things that I like about writing stock options is that I can write a put. A put means that I am willing to buy shares in a certain stock at a price that I choose for a certain period of time that I choose and because I am insuring you that I will do that, I am paid a premium, in advance. So, for example, suppose I insure you that I will buy 100 shares of stock at say $24.00 for the next 3 months, and the agreed upon premium I charge you for this assurance is $1.00 per share, I only have to post $23.00 (plus your $1.00) to insure the $24.00 price. My money, through the brokerage firm is held in my account with restrictions. If you do not sell me the shares within the 3-month period, my money is released the day following the end of your insurance period. If the stock collapses to say $10, I am obligated to buy your shares at $24.00 and I then have a huge underwriting loss. However, I now have possession of the shares and I can make new maneuvers to try to recover my money and to even make money. Obviously, in this case, I should have bought reinsurance at say $20 for a matching 3-month period so that my potential loss would be limited so that when you sold me the stock that is current selling at $10 at $24, I in turn would sell the shares at $20 probably for a net loss of $3.75 and not $14.00.
I suggest you not get involved in selling options unless you would really like to do this for a living. You can sell covered call options and earn money over and beyond what the dividends yield as well as set up selling prices, which gives you a substantial profit potential. For example, I recently bought CCL (Carnival Cruise Lines) at $48.13 and had sold 60-day call options at $55 for $30 per 1 contract. The options expired Oct 23 with the stock price below $55.00 and the stock price is now $53.58. Rather than again sell a new $55 call option, I sold various $60 call options for $30 and $40 per contract. Those options expire in January 2016, 2-months from now. That adds to my $30 (per 100 shares) quarterly dividend. (As long as I hold the shares, I get the dividend). If I sell the shares at $60 by January 15, 2016, I would be happy and it starts the New Year at a very nice profit for me. If the stock only rises to say $59.00 a shares by expiration, I will still have the shares I own and can then decide what I should do. I may sell a $60 call for a fat premium or maybe sell $65.00 calls thereby increasing my risk and profit potential. However, I will not need to make that decision until January 2016. By the way, if the stock, which is currently $53.58, starts to go down, I may decide to buy back the call I sold $30 and at $40 for say $5.00 per contract grossing me $25.00 to $35.00 per contract and allowing me to sell a new call contract when the stock price rises. Like I said, there are many facets to writing stock options
Here is a risky put option that I have done this week. I am confident that the stock, LINE, will not go down to $2.00 or below by Nov 20, 2015. I sold $2.00 puts for $20.00 per 100 shares. The potential annualized return is in excess of 120%. There are only 4 more weeks until expiration. The closing stock price on Friday Oct 23, 2015 was $2.60. The 52-week high-low is $25.69 -$2.01. Low oil and gas prices hurts this company, which no longer is paying a monthly distribution.
Warren Kaplan has been writing options for 50 years. He has been a stockbroker, investment banker and brokerage owner. He currently owns and operates Kaplan Asset Management, a provider of financial assistance for small to middle market businesses. He has more than a half-century of experience in dealing with financial markets, giving guidance and consulting with management, and assisting in the development of business strategies and solutions. The Company has assisted and consulted many successful companies, such as Natures Bounty (NBTY) and Action Products International (APII), helping them to go public and trade on the NASDAQ stock exchange. His philosophy is to “do something with the profits.” “If you make $100 in the stock market, take 50 percent and invest it back into the market. Then, take the other 50 percent and buy yourself something.”
Additional disclosure: I am not a registered investment adviser and I do not give investment advice. Nothing in this article should be construed as investment advice. Investors are encouraged to do their own research and seek the advice of an investment professional before investing. Writing options is not for everyone. This article was written for informational purposes only.