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Originally Posted by Beachbumz
I welcome any experiences or thoughts on these strategies.
Beachbumz 8)
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Howdy Beachbumz. I've tried this approach a few times in the past several years. A few comments:
Realize that the option premium is composed of two parts:
-Risk free interest rate, combined with the time until expiration (curently low, but steadily rising, which really screwed up option premiums over the past 2 years)
-Implied volatility of the stock price (the more volatile the price is, the larger the premium.)
While it might sound like a great theory to sell a 45 put if the stock is at 50, if the stock does drop to 40 and you get exercised and buy it at 45, you won't get didley squat for a 45 call unless you go out 6-12 months. (and even then don't expect a huge premium) If that 45 put has a $2 premium while the stock's at 50, there's a reason it is that large.
Granted, you mentioned a stock that pays a dividend, and that is a good backup plan...but don't forget to include the dividend amount in your option calculations:
Ex: Stock trades at 50. Annual yield is 3% (1.50 dividend). If you write a 45 put that will cover two ex-dividend dates, you should subtract .75 from that put premium, since the stock will go ex-dividend and drop .75 for those two dividends, and put you that much closer to being exercised. Granted, in the long run, a well-run company will recover the amount of the ex-dividend with capital appreciation, but it will put you that much closer to exercisement in the short-term.
Also, I presume that you will be buying the stock on margin? If not, that means you have a hefty pile of cash just sitting there. Either way, you have to either incorporate margin loan expenses (currently about 5%), or the lost value of your cash just sitting there in a MM account earning 1.5% when it could be in a 5-year Pen Fed CD earning 5%.
So, you have to do an opportunity cost analysis of what else that money could be doing while it's either sitting idle, or to include your margin loan (note: Margin Loan interest IS tax deductible, offsetting your taxable dividend income, in many cases. Consult your tax advisor or the IRS website).
Having said all of that...I'll be brave enough to admit that I'm an option fool player that does follow that strategy.
However, rather than use your good idea of dividend plays, I prefer to write puts on stocks that have a metoric plunge in a single day due to 'bad-but-not-terrible' news.
For instance, a few months ago Sanderson Farms (SAFM) came out with earnings that missed slightly. The stock cratered from the mid 40s to the mid 30s. The volatility mushroomed due to the stock movement. I took the opportunity to buy the stock at 36.37 and wrote a covered 35 call (essentially, similar to writing a naked put) and picked up 5.10 in option premiums. My net cost in the stock was 31.27, and it was trading at 36. Sure, it was called away at 35 a few months later, but I just couldn't see the stock trading as low as 31....and even if it had dropped THAT low, I would simply repeat the process and sell another covered call. The only thing to worry about is if it drops A LOT more, and the only calls that offer any decent premium are too far below your cost to 'guarantee' you will make money if the stock gets called away.
Typically, the dividend paying stocks that pay any decent dividend aren't that volatile (beleagured car manufacturers excepted
), so I wouldn't expect MOST of them to offer fat option premiums (I'm sure there are exceptions).
Let me know if you come across any good dividend/option plays Beachbumz. My current plays are
WIRE (price: 11.30, cost with option premiums is 10.20, August 12 1/2 call currently written)
HDI (sold the November 42 1/2 put the day it was hammered down to 47 1/2), PKZ (OUCH....sold total of 6 August puts, average strike price of 37 1/2 with 4.80 in premiums...currently down at 26!!!)
ENDP (July 17 1/2 put for 1.15, stock is at 20.43)
UTSI (sold Jan 2006 12 1/2 put for 1.7, back when the stock was at 17 1/2. Now it's at 7 and some change....double ouch!)
Peter