Today, May 7, I bought 100 shares of Pepsi (PEP) for $99.07 per share and simultaneously “sold to open” one July 20, 2018 $100 call option for $2.42 per share.
This is my latest “high-yield trade” — a strategy designed to generate above average income from some of the best companies in the world.[hana-code-insert name=’adsense-article’ /]By selling the call option on PEP, I’m giving the buyer of the option the right, but not the obligation, to purchase my 100 shares at $100 per share (the “strike” price) anytime before July 20 (the contract “expiration” date).
In exchange for that opportunity, the buyer of the option paid me $2.42 per share (the “premium”).
Because I collected immediate income when the trade opened, I immediately lowered my cost basis — after commissions and fees — from $99.07 per share to $96.71 per share. In other words, I bought the stock at a 2.4% discount to its share price when I placed the trade today.
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 PEP shares climb to $110, for example, I’ll still be forced to sell at “just” $100)… but I’m generating a decent-sized income in the process.
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.
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: PEP stays under $100 by July 20
If PEP stays under $100 by July 20, I’ll get to keep my 100 shares.
In the process I’ll also have received $242 in call income ($2.42 x 100 shares).
The call income, or premium, was collected instantly today. 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 $236.40 in profit after commissions and fees.
On a percentage basis, I received a 2.4% yield for selling the call ($2.42 / $99.07).
When I account for commissions and fees I’m looking at a 2.4% yield in 74 days, which works out to a 11.8% annualized yield.
Scenario #2: PEP climbs over $100 by June 20
If PEP climbs over $100 by July 20, my 100 shares will get sold (“called away”) at $100 per share.
Like “Scenario 1”, I get to keep the $242 in call income ($2.42 x 100 shares). I’ll also generate a $93 capital gain ($0.93 x 100) since I bought at $99.07 and will be selling at $100.
In this scenario, after commissions and fees I’ll be looking at a $324.45 profit.
From a percentage standpoint, this high-yield trade will deliver an instant 2.4% yield for selling the call ($2.42 / $99.07) and a 0.9% return ($0.93 / $99.07) from the capital gain.
After subtracting out the commissions and fees, I’m looking at a 3.3% total return in 74 days.
That works out to a 16.2% annualized yield from PEP.
Compare that figure to the stock’s “regular” yield of 3.75%.
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.
Please keep in mind that these “High-Yield Trade” alerts are for information purposes only. We’re not registered financial advisors and these aren’t specific trade recommendations for you as an individual. Each of our readers have different financial situations, risk tolerance, goals, time frames, etc. The ideas we publish are simply ideas that we feel fit our specific needs and that we’re personally making in our own portfolios. You should also be aware that some of the trade details (specifically stock prices and options premiums) are certain to change from the time we make our trade to the time you’re alerted about it. So please don’t attempt to make this “High-Yield Trade” yourself without first doing your own due diligence and research.[hana-code-insert name=’MMPress’ /]