Thursday, May 03, 2007

Gold Stocks - Trade Idea Part 2

Last time, I talked about naked put selling on gold stocks that you wouldn't mind owning. Let's assume, following the earlier example, that at the end of May you are 'put' into Barrick Gold Corp because the stock traded lower than the strike price of the put options you wrote (i.e. $30 USD).

This means that you are now the proud owner of 500 shares of ABX. What can you do? You could hold the stock and hope it goes up or you could sell the stock for a slight loss (remember, it must be less than $30 because you were 'put' into the stock). Alternatively, you could write covered calls on the stock.

So, what is a 'call'? A call option is an agreement that gives an investor the right (but not the obligation) to buy a stock (or some other other financial instrument) at a specified price within a specific time period. If you sell someone the right to buy stock that you own, then this is a covered call.

Imagine now that you sell 5 call contracts that expire in one months' time at the $30 strike price. Imagine that each contract is trading at $0.75. This would mean that you would receive:
  • $0.75 x 500 or $375 for selling someone the right to buy your stock in one months' time!
If at the end of next month, the stock is trading below the strike price of $30, then you keep your stock and the $375 that you made on the call options. For argument's sake, if the stock is trading at $50, you are obligated to sell your stock for $30. In other words, if on the day of expiration for your call option, ABX is trading at any price over $30, you must deliver your stock for $30.

Let's assume now that for one year, you write naked put options for ABX, and when you are put into the stock you write covered calls. Moreover, when you called to deliver your stock, you write naked puts for the following month. In other words, every month that goes by, you either own ABX and sell covered calls, or don't own ABX and sell naked puts.

Let's also assume that your monthly premium on the option writing is approximately $0.85. Then each month, you generate about 500 x $0.85 or $425. For the year, you would generate about $5,100. Remembering that you had to initially have $15,000 in your account to cover the naked put options, you are looking at yearly rate of return of about 33%. Not too shabby!

  • I am not be liable for any investment decision made or action taken based upon the information on this page.
  • I suggest you check with a broker or financial adviser before making any stock investing decisions.
  • I am not offering financial advise, but rather commenting on widely available investment strategies.
  • Options trading can be extremely risky.
  • Finally, Caveat emptor!

No comments: