Apple & Portfolio Overwriting

08/06/2020 9:24 am EST

Focus: OPTIONS

Alan Ellman

President, The Blue Collar Investor Corp.

Alan Ellman presents an alternative covered call writing strategy in Apple.

Portfolio overwriting is a covered call writing alternative strategy. Our goals include increasing our returns by a modest amount while still retaining ownership of the shares. Deep out-of-the-money strikes are sold with specific annualized returns in mind, let’s say 6% for purposes of this article.

Apple Inc. (AAPL) is a widely held stock by many of our members who look to leverage these securities to generate additional income. In January 2020, AAPL had been on a bullish tear with share price rising exponentially (see chart below). 

aapl
AAPL: One-year Chart as of Jan. 22, 2020

Portfolio overwriting trade entered Dec. 24, 2019 (one-month return)

  • Dec. 24, 2019: Buy AAPL at $284.27
  • Jan. 24, 2020: Sell $315 call at $1.75
  • Goal is an annualized 6% or 0.5% per month return

covered call

overed call Writing Calculations with The Ellman Calculator

A 0.6% one-month time-value return approximates our 0.5% goal with a huge 10.8% upside potential (130% annualized). Selling deep out-of-the-money calls similar to this $315 strike will normally have Deltas of <0.15, meaning less than a 15% chance of expiring in-the-money. However, as we can see from the chart above, AAPL out-paced even this strike and was trading at $318.60 on expiration Friday (Jan. 24, 2020).

Trade status 3 p.m. EST on expiration Friday, Jan. 24.

With AAPL trading at $318.30, the cost-to-close the $315 call was $3.50, double the amount we generated from the initial option sale. If we buy-to-close the short call, are we losing money? Heck no!

Final trade overview

We maximized our trade as it was initially established with a 0.6% time-value option profit + a 10.8% upside potential for a total one-month profit of 11.4%. That’s not losing money. Now, if we close, of the $3.50 we pay, $3.30 is intrinsic-value driving the value of our AAPL shares from the $315 contract obligation to current market value of $318.30. The actual time-value cost-to-close is 20¢ or 0.06%. We can now write another deep OTM call with a target 0.5% one-month initial time-value return.

On Thursday, AAPL had a favorable earnings release. A critical Blue Collar Investor rule is never to have an option in place that expires after an earnings report. This matter can be circumvented by using weekly options the month of the report. Avoid the week of the report and then return to monthlies. If our annualized goal is 6%, our weekly target would be approximately 0.1%. If AAPL is trading at $400, our weekly time-value return goal would be about 40¢. 

Discussion

Portfolio overwriting is a covered call writing alternative strategy geared to increasing returns on long-term buy-and hold stocks. Deep out-of-the-money strikes are used with a set target annualized return in mind. Should a strike end up in-the-money as expiration approaches, we can buy-to-close with a miniscule time-value debit.

Use the multiple tab of the Ellman Calculator to calculate initial option returns (ROO), upside potential (for out-of-the-money strikes) and downside protection (for in-the-money strikes). The breakeven price point is also calculated. For more information on the PCP strategy and put-selling trade management click here and here

Related Articles on OPTIONS

Keyword Image
Trade of the Week: Workhorse
09/18/2020 10:00 am EST

Investors have been very high on electric vehicle companies, so far this year, explains Jay Soloff.&...