Put and call strategy, potential premium income

Question:

In your August 10 answer to a question about puts and calls,  you write “The investor is whipsawed into buying above the market price and selling below market price. Nevertheless, the premium income often is more than sufficiently high to offset the pain.”

How much  premium income can put and call writing produce? On how many shares do you write  puts/calls?

Monday Morning Millionaire Program Answer:

Investors always make money writing (selling) calls and puts. However, if the optioned security moves in the wrong direction, investors face an opportunity cost which could exceed their premium income. If that happens, investors will not have made as much money as they would have, had they not written the call or the put. It has been said that you cannot go broke taking a profit (unless you are losing big money and somewhere else).

Now, the best that people who follow the seven habits of highly effective investors can do is to equal the market minus a small transaction cost. That approach has done well in the past and is likely to do so in the future. Conservative investors are happy with that result. Over 90% of investors, professionals included, cannot equal it over a decade or more.  The only way to beat the market is to depart from one or more of these habits. Let us again, look at them again. 

  1. Having an early, disciplined savings program
  2. Self-directed (do-it-yourself) investing
  3. Buying the entire US market
  4. Buying and holding
  5. Buying low, selling high
  6. Having cash most of the time
  7. Avoiding complexity

In our explore portfolio we have been writing calls and puts on ABBV — the premiums have been so high, we could not resist. By picking an individual stock, we have abandoned the third habit which is to buy the entire US market and not pick individual stocks.

On July 23 of this year, we sold calls on ABBV with a strike price of $89.00 (just out of the money) and expiry date, July 27 and received $2.01 per share.

Here is the math:

  • Income per share = $2.01
  • Percentage income per share for the week = $2.01/$89.00 = 2.26%
  • Percentage income per share, annualized = 2.26% x 52 =117.44%

How sweet can it be? Unbelievable, right?

Well, ABBV, a biopharmaceutical company was formed in 2013 as the result of a spinoff of Abbott Laboratories. With some fluctuations, this darling of market analysts has been going straight up. We happened to buy it at the peak of one of these fluctuations and have incurred a loss, bigtime, premium income notwithstanding!

I am delighted, however, to answer your second question. We are doing this in our fun portfolio which makes up only 11% of our market investments.

The benefit of straying from one or more of the seven habits in a small, fun portfolio is that the investor cannot be hurt badly. Another advantage is that it often makes good cocktail party conversation. The downside, of course, is that the investor can never make a great deal.

Adhering to the seven habits, based on history, we can expect good returns with instantly quoted prices, low transaction costs, absolute liquidity and good, reliable record keeping.

Who could ask for more?

 

 

 

 

 

 

 

 

 

 

 

 

When you do this,

Effectiveness of the put-and-call strategy

Dr. Milan Somborac

The Monday Morning Millionaire Program supports do-it-yourself (DIY) investors which I have been for over 50 years. About my team and me