On Friday, October 6, I bought 100 shares of PepsiCo (PEP) for $110.04 per share and simultaneously “sold to open” one November 17, 2017, $110 call option for $1.99 per share.
It’s my latest “high-yield trade” — a strategy designed to generate above average income from some of the best companies in the world.
In exchange for that opportunity, the buyer of the option paid me $1.99 per share (the “premium”).
Because I collected immediate income when the trade opened, I’m lowering my cost basis on the shares I’m buying.
This is precisely what makes a “high-yield trade” safer than simply purchasing shares of the underlying stock the “traditional” way.
Yes, I’m limiting my potential upside (if PepsiCo shares climb to $115, for example, I’ll still be forced to sell at “just” $110)… but I’m still generating enough immediate income in the process to justify it.
It’s a trade-off… and one I’m willing to make because this strategy, by its very nature (selling a call option instead of buying one), is designed to be conservative and to generate income. For this reason, it’s been called “the greatest income-producing tool for retirees.”
With all of this in mind, there are likely two ways this trade will work out — and they both spell high annualized yields on my purchase price…
Please note: To be conservative, I don’t include any dividends in my calculations for either of the following scenarios. Any dividends collected are just “bonus” that will boost the overall annualized yields even further.
Scenario #1: PepsiCo (PEP) stays under $110 by November 17
If PepsiCo stays under $110 by November 17, I’ll get to keep my 100 shares.
In the process I’ll also have received $199 in call income ($1.99 x 100 shares).
The call income, or premium, was collected instantly on Friday. It was deposited in the account where I made the trade, which is my 401(k) retirement account.
At the end of the day, if “Scenario 1” plays out I’ll be looking at $193.35 in profit after commissions and fees.
On a percentage basis, I received a 1.8% yield for selling the call ($1.99 / $110.04).
When I subtract out the commissions and fees I’m looking at a 1.8% yield in 42 days, which works out to a 15.3% annualized yield.
Scenario #2: PepsiCo (PEP) climbs over $110 by November 17
If PepsiCo climbs over $110 by November 17, my 100 shares will get sold (“called away”) at $110 per share.
Like “Scenario 1”, I get to keep the $199 in call income ($1.99 x 100 shares). I’ll also generate a $4 capital loss (-$0.04 x 100) since I bought at $110.04 and will be selling at $110.
In this scenario, after commissions and fees I’ll be looking at a $184.40 profit.
From a percentage standpoint, this high-yield trade will deliver an instant 1.8% yield for selling the call ($1.99 / $110.04) and essentially a 0.0% gain/loss (-$.04 / $110.04).
After subtracting out the commissions and fees, I’m looking at a 1.7% total return in 42 days.
That works out to a 14.6% annualized yield from PepsiCo. Not bad, considering the stock’s “regular” yield is 2.9%.
P.S. I only made this trade because: 1) I want to own the underlying stock anyways 2) I believe it was trading at a reasonable price when I made the trade 3) I am comfortable owning it for the long-haul in case the price drops significantly below my cost basis by expiration and 4) I am comfortable letting it go if shares get called away. To be mindful of position sizing, except in rare cases, the value of this trade wouldn’t exceed 5% of my total portfolio value. In addition, to minimize taxes and tax paperwork, I made this trade in a retirement account.