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How To Generate Monthly Cash Flow And Purchase Stocks At A Discount Using Two Low-Risk Option Strategies
Covered Call Writing and Selling Cash-Secured Puts
Hosted by:
Dr. Alan Ellman
President of The Blue Collar Investor Corp.

2. Strategy Overview
Sell call and put options to generate monthly cash flow
Sell OTM puts to buy stocks “at a discount”
Sell OTM call options to enhance returns for a buy-and- hold portfolio
Use both covered call writing and put-selling to develop a multi-tiered option selling strategy
Zero-dollar collar to protect low cost basis stocks 2

3. Three Essential Skills
Stock or ETF selection
Option selection
Position management 3

4. Definitions
Call option- Gives the holder the right, but not the obligation to buy 100 shares of stock at a fixed price by a specified date. Call options will be used in the PCP (put-call-put) strategy
Option- A contract that gives the holder the right, but not the obligation, to buy or sell 100 shares of stock at a fixed price (called the strike price) by a specified date (called the expiration date). It is the right to execute a stock transaction.
Put option- Gives the holder the right, but not the obligation to sell 100 shares of stock at a fixed price by a specified date. 4

5. “Moneyness” Of An Option Relationship of the strike price to the price of the stock
Puts (Stock $/strike $)
Calls (Stock $/strike $)
OTM ($32/$30)
ATM ($30/$30)
ITM ($28/$30)
OTM ($28/$30)
ATM ($30/$30)
ITM ($32/$30) 5

6. Option Premiums In Relation To Stock Price
Premium = intrinsic value + time value
Intrinsic value = amount ITM (only for ITM strikes)
Time value: Total premium – intrinsic value
All premiums consist of time value only for ATM and OTM strikes 6

7. Preview Example For Calls
Purchase 100 shares of Company $48 per share = $4800.
Sell an option: sell someone the right to buy these shares for $50 per share during the next month.
You are paid a premium of $1.50 per share = $150.
This is a 3.1% 1-month return = 37% annualized. 7

8. PREVIEW SCENARIO I
At the end of the month, the stock price is less than $50; your shares are NOT purchased.
You keep your 3.1% 1-month profit and are free to sell another option. 8

9. PREVIEW SCENARIO II
At the end of the month, the stock price is above $50 per share and your shares ARE purchased.
You now make an ADDITIONAL $200 on the sale of the stock.
Total 1-month profit is $350 = 7.3% 1-month return = 87% annualized! 9

10. Real Life Trade With PRLB
9/23/13: Buy 100 x $78.10
Sell 1 x October $3.30 = initial 1-month return of 4.2%
10/8/13: BTC $80 $0.45 (slightly above the 10% guideline)
10/14/13: STO $80 $1.40 (“hitting a double”) for an additional $95/contract credit
10/18/13: Allow assignment as stock is trading above $80 and there was an upcoming earnings report on 10/31/13
10/19/13: Shares are sold for $80 for an additional $190 per contract $78.10)
Total profit = $330 + $95 + $190 = $615 = 7.9%, 1-month return 10

11. PRLB: 1-Year Chart 11

12. PRLB: 1-Month Chart 12

13. Summary Of Principles, Rules And Guidelines Used
Stock selection using fundamental and technical analysis as well as common sense principles
Option selection based on market assessment, chart technical and risk tolerance
Exit strategy execution using 20/10% guidelines
Expiration Friday decision based on earnings report rule 13

14. Preview Example For Puts
Stock BCI is $75
The out-of-the-money $72.50 put is selling for $2 for a 1-month expiration
We deposit $7, into our cash brokerage accounts per 100 shares of obligation
We sell the put option for $200 per 100 shares of obligation
This option premium is ours to keep no matter what transpires by the end of the contract
We are now obligated to buy BCI $72.50 per share should the option buyer choose to exercise the options
Our initial profit from the put sale = $200/$7050 = 2.8% (less trading commissions)
This annualizes to a 34% return 14

15. PREVIEW SCENARIO I
If the price of BCI remains above the strike price (agreed upon sales price of $72.50), the option buyer (holder) is not going to elect to exercise the option and sell shares to us at a price lower than the current market value.
Option will expire worthless, we will have generated our 2.8%, 1-month return and the cash is now freed up to secure another put sale the next contract month. 15

16. PREVIEW SCENARIO II
Price of BCI does drop below the $72.50 strike price in which case the option will be exercised and the shares sold to us.
The cash previously deposited into our brokerage account is used for this purchase.
The cost basis we now own this stock at is $70.50, the $72.50 we paid for it less the $2 put premium we generated from the original option sale.
At this point the put seller who is now the share owner can take one of the following paths:
Sell the stock
Hold the stock long term
Write a covered call on the stock (giving the option buyer the right to buy these shares from us) to generate additional income 16

17. 3-Pronged Approach To Creating A High-Quality Watch List
Fundamental Analysis: Earnings and revenues
Technical analysis: Reading a price chart
Common sense principles (diversification) 17

18. Premium Stock Screen 18

19. Premium Watch List 19

20. Option Selection: “Moneyness” And Expiration (1-month) 20

21. Covered Call Writing Returns 21

22. Put-Selling Returns 22

23. Factors That Influence “Moneyness” Decisions
Identify our goal
Overall market assessment
Chart technicals
Personal risk tolerance
Calculations meet our initial goals (2-4%/month) 23

24. “Moneyness” For Puts
First establish goal (income only, discount, use with ccw)
*OTM- Most conservative ($32/$30)
ATM- More aggressive ($30/$30)
ITM- Most aggressive ($28/$30): exercise most likely 24

25. “Moneyness” For Calls
OTM- Most aggressive ($28/$30): highest potential returns
ATM- Aggressive: highest initial returns ($30/$30)
ITM- Most conservative ($32/$30) 25

26. Integrating Both Strategies: PCP Strategy 26

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29. First Q&A
About 15 minutes 29

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35. 15 minute break 35

36. Portfolio Overwriting
Enhance the returns of a buy-and-hold strategy
To increase by 6% per year, our goal is ½% per month
Use out-of-the-money strikes to allow for share appreciation 36

37. Advantages Generate a constant, guaranteed monthly cash flow
Downside protection in bearish markets
Most retail investors are granted this level of trading approval
Can be used as an additional monthly source of income 37

38. Disadvantages Early exercise may result in tax consequences
Share appreciation is limited by the strike price
Learning curve
Modest time commitment 38

39. Why Is Early Exercise So Rare?
Call buyer can keep cash in an interest-bearing account until the last minute
Call buyer exposed to greater risk because stock price > option price
Loss of time value of option- call buyer makes more money selling the option 39

40. What If Stock price > Strike Price By Expiration Friday?
Easy to avoid exercise and sale of shares
Roll the option: buy back current month option and sell the next month option prior to 4PM EST
Roll out- same strike
Roll out and up- higher strike 40

41. Early Exercise And Dividend Distribution
Ex-dividend date close to expiration Friday
Call strike is in-the-money (lower than stock price)
The dividend is > time value of the option 41

42. How To Avoid Early Exercise
Access ex-dividend dates
Sell option the day after the ex-date
Sell a 2-month option 42

43. Ex-Dividend Date For AXP 43

44. Guidelines For Avoiding Early Exercise
If the ex-date is in the 1st week of a contract, sell the option the next day
If the ex-date is later in the contract, sell a 2-month option after expiration of the previous contract 44

45. Assumptions For Practical Application
Long-term buy-and-hold portfolio with shares at a low cost basis
Goals to generate higher returns and avoid exercise
Roll options if strike is ITM by expiration
Sell options the day after the ex-dates in the 1st week of a contract
Sell 2-month options if later in contract
Our goal is an additional 6% per year 45

46. Home Depot: Ex-Date 46

47. Home Depot: 1-Month Options Chain 47

48. 1-Month Returns $41/$8044 = 0.51%, about ½%
Share appreciation potential to $83=
$83 - $80.44/$80.44 = 3.1% 48

49. Home Depot: 2-Month Options Chain 49

50. 2-Month Returns Goal is now 1% to annualize to 6% Goal is about $0.80
Choices include the $82.50 $1.06 and the $85 $0.44
With multiple contracts use 1/2 of each to average to 1%
If a single contract favor the lower goal for less need to roll the option 50

51. Summary
Portfolio overwriting is a low-risk way of enhancing portfolio value
In non-sheltered accounts, avoiding exercise is important if the cost basis is low
Dividend distribution is the main reason for early exercise
Covered call writing limits share appreciation to the strike 51

52. Using a Zero-Dollar Collar to Protect Low Cost Basis Stocks 52

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54. Summary to Master Option-Selling
Must master all 3 required skills
Stock selection: (fundamental analysis, technical analysis, common sense principles)
Option selection: (“moneyness”, expiration date, returns meet goals)
Position management: (bullish and bearish scenarios) 54

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62. Covered Call Writing And Put-Selling62
Covered Call Writing And Put-Selling
Generate Monthly Cash Flow using Two Conservative Option Strategies
Hosted by:
Dr. Alan Ellman
President of The Blue Collar Investor Corp.