Covered Calls and Covered Puts - Empirical Results and Lessons Learned

Noah Kiedrowski - INO.com Contributor - Biotech


Leveraging Options

I’ve written numerous articles on options trading and how one can leverage options over the long-term to mitigate risk, generate income and accentuate returns. Leveraging options to supplement portfolio returns can make a meaningful impact on overall returns, especially over the long-term. Here, I’ll focus on covered calls and covered puts with corresponding lessons learned over the course of the past year with empirical data.

Covered calls are intended to leverage a stock position while extracting value on a consistent basis via selling option contracts against that position and collecting premium income in the process. I liken this to a landlord renting a room for monthly income, however, in this case, one is renting the stock. The option contract is structured with the option seller (stock owner) collecting a premium in exchange for the right for the option buyer to purchase the shares of interest at an agreed upon price by an agreed upon date for a premium (income that the option seller will receive). In this scenario, the stock owner doesn't believe that the shares will appreciate beyond the agreed upon price and thus be able to collect income while retaining the shares and dividend rights. The option buyer believes that the shares will appreciate beyond the agreed upon price and be able to buy the shares at a lower price than the market currently trades.

Covered puts involve leveraging a cash position that one currently has on hand and collecting a premium in exchange for the obligation to purchase one’s shares at an agreed-upon price prior to an agreed upon date. If the stock falls below the agreed-upon price prior to the agreed upon date, then the individual that bought the contract from you will force the obligation (that you agreed to) for you to purchase the shares. In this case (when the stock falls throughout the contract lifespan), the shares can be sold to you (the put option seller) at a higher price than the market. However, if the shares rise in value then the shares will remain with the owner and the put option seller will keep the premium income and the cash earmarked for the potential purchase of the shares will be freed. Why exercise the contract and sell the shares to you (option seller) at a lower price when one can sell the shares on the open market at a higher price? Continue reading "Covered Calls and Covered Puts - Empirical Results and Lessons Learned"

Initiating a Position, Generating Income or Lowering Cost Basis - Covered Puts

Noah Kiedrowski - INO.com Contributor - Biotech


Levering cash with options

I’ve written numerous articles on options trading and how one can leverage options over the long-term to mitigate risk, generate income and accentuate returns. Leveraging options to supplement portfolio returns can make a meaningful impact on overall returns, especially over the long-term. Here, I’ll focus on covered puts, covered in the sense that one is backing his option contract with cash on hand. This strategy generates income in the form of a premium that’s received by the option seller. A topic that’s rarely covered is the different objectives or strategies and what to do about shares that are assigned from a covered put contract. Here, I’ll focus on covered puts and discuss the strategy involved before selling a put contract, objectives when engaging in these put options and if/when shares from the contract are assigned. Continue reading "Initiating a Position, Generating Income or Lowering Cost Basis - Covered Puts"

High-Quality Covered Puts - 78% Win Rate

Noah Kiedrowski - INO.com Contributor - Biotech


Introduction

I’ve written many articles highlighting the advantages options trading and how this technique, when deployed in opportunistic or conservative scenarios on a consistent basis may augment overall portfolio returns while mitigating risk in a meaningful manner. Here, I’d like to focus on leveraging cash to engage in options trading, more specifically selling covered puts. Here, I’d like to cover my approach and results in layman's terms about strategy and empirical outcome with commentary.

In short, I’m committing cash to purchasing shares in the future at an agreed upon price while being paid a premium. Usually, this agreed upon price is significantly higher than it currently trades and when factoring in the premium income, the agreed upon price will be slightly lower than the current price. Put another way; I’m committing cash to buying shares in the future for less than the stock trades today. Therefore, the seller of the option contract (in this case me) believes the price will increase, and the buyer (stock owner) believes the price will fall. The stock owner (buyer) and is purchasing insurance in the event the stock falls (paying for the right to sell the stock at an agreed upon price and date). As the stock appreciates in value and approaches the agreed upon price within the contract time frame the shares will be kept by the owner (buyer), and I keep the premium. If the shares decrease in value, then the shares will be sold to me at the agreed upon price (less the premium). My objective is to leverage cash and generate income without owning the underlying shares of the company via options contracts. Continue reading "High-Quality Covered Puts - 78% Win Rate"

Mitigating Risk, Accentuating Returns and Realizing Gains - 27.9% Return

Noah Kiedrowski - INO.com Contributor - Biotech


Introduction

I’ve written a series of articles detailing the utility of options trading and how an investor can leverage a long position in an underlying security to mitigate risk, augment returns and generate cash. This strategy comes with two alternatives, in the end, depending on whether or not one desires to realize gains and relinquish his shares or remain long the security of interest. I’d like to highlight Salesforce.com Inc. (NYSE:CRM) as an example for this covered call strategy. I’ll be highlighting how I’ve successfully accentuated my returns via leveraging the underlying security in the form of collecting option premiums over a 20-month span. In this example, I decided to ultimately realize gains generated from the underlying appreciation of the stock combined with the options income and relinquish my shares. Taken together, the synergy of the options income and appreciation of the underlying security generated a realized gain of 27.9% over this timeframe.

I’m utilizing a high growth technology stock that’s at the intersection of syncing the customer and enterprise relationship via social, mobile and cloud platforms. Salesforce is a contentiously debated aggressive growth stock that trades on lofty valuations. Salesforce is marginally profitable and thus difficult to assign a valuation as measured by traditional metrics such as the price-to-earnings multiple (P/E ratio) and the PEG ratio. Due to its rapid growth, expanding footprint, major partnerships with Fortune 500 companies (i.e. Home Depot, GE, Wells Fargo, Coca-Cola, etc.), expansion into international markets and its overall ubiquity in terms of its consumer relationship management (CRM) platform, it's reasonable to see why investors are willing to pay a premium. Much of its revenue is deferred as a result of its subscription-based model thus deferred revenue is often discussed on earnings calls. Deferred revenue is not yet realized revenue however it’s been received by the company. Since Salesforce delivers its service over time, this received amount isn’t reported as traditional revenue since the service hasn’t been rendered. Due to these factors and the difficulty of placing an accurate valuation on Salesforce, options in the form of covered call writing may be an effective way to leverage this growth stock while mitigating downside risk. Salesforce offers the right balance of volatility, liquidity and a high level of interest which gives rise to reasonable yielding premiums on a bi-weekly or monthly basis. This set-up bodes well for those who are long Salesforce (or a stock similar in nature) and desire to leverage options trading to augment returns and mitigate risk throughout the volatile nature of this underlying security. Salesforce’s recent string of earnings has impressed investors, and covered call options may accentuate this underlying equity return. Writing covered calls in an opportunistic and/or disciplined manner may mitigate losses and smooth out drastic moves in this underlying security. Continue reading "Mitigating Risk, Accentuating Returns and Realizing Gains - 27.9% Return"

Realized 14% Gain After Netflix's Recent Beat - Without Owning Shares

Noah Kiedrowski - INO.com Contributor - Biotech


Introduction

Netflix Inc. (NASDAQ:NFLX) recently reported stellar quarterly numbers alongside robust subscriber growth that propelled the shares from ~$100 to $120 by the next day and ultimately to $130 within a few days (Figure 1). Netflix announced that it brought in 370 thousand net subscribers in the U.S. during Q3 while posting only 160 thousand net subscribers during the previous quarter. Furthermore, its international strength was very robust, adding 3.2 million against a 2.0 million consensus. Netflix’s guidance was higher than most estimates as well coming in 520 thousand and 3.75 million subscribers domestically and internationally, respectively. I’ve written a series of articles highlighting ways to leverage options trading to augment a long position or potentially entering into a position in Netflix. I’ve highlighted ways in which one can layer in covered calls to mitigate risk in a long position as well as utilizing secured puts to enter into a position at a lower price or avoid owning the stock altogether while making money. I’ll discuss my covered call/secured put combination strategy to unlock additional value, mitigate risk and generate income. I’ll break this strategy out into segments to exemplify the power of options when dealing with an intrinsically volatile stock with significant upside potential such as Netflix. In brief, I’ve realized a 13.2% gain relative to a -3.1% loss based on the traditional buy and hold strategy based on the closing price on 11Nov16 of ~$115.

Netflix Inc. (NASDAQ:NFLX) Chart
Figure 1 – Netflix’s upward movement after announcing numbers that beat analysts’ expectations

Overview

Netflix is a highly volatile stock with a 52-week range of $80-$133 per share or a $53 per share range. Layered within that range are swings of $10 per share or more (~10%) throughout the course of any given day. These swings to the upside or downside can be difficult to stomach especially after the most recent earnings announcement where the stock cratered by $15 per share in one day (~$100 to $85). There’s no disputing the fact that Netflix has an outrageous valuation and a wide range of intrinsic volatility. Case in point, a $20 move per share was witnessed the day after Netflix beat expectations when they announced Q3 numbers. This intrinsic volatility is more pronounced during any major news story (i.e. expansion into international markets or subscriber price increases) and specifically around earnings announcements. As a result of the nosebleed valuation and volatility, in my opinion, options are a great companion when committing capital to Netflix stock. Continue reading "Realized 14% Gain After Netflix's Recent Beat - Without Owning Shares"