Options Trading is not for Everyone

What I have learned about Options Trading

It has been some time since I posted my options trades in this blog. The reason is that my options trading volume has increased. I also suspect what I am doing won’t be of much help to many of my readers. I have expanded my options trading to three types of trades and have learned some important lessons. As I have continued to trade options, I believe those with less than $500K to invest should stick to low cost dividend growth ETFs and avoid options trading. If, however, you are open to some income opportunities with relatively little work, trading options can be another arrow in your investing quiver.

The Types of Options

The focus of my trades has been 98% covered calls. Covered calls are easy to understand and take very little time to research and enter. In essence, I am selling “insurance” to other investors. I’m committing to sell my shares at a certain date for a certain amount, even if the price of the shares is much higher than the price I set. For that opportunity, others give me money.

The second type is called a cash-covered put. This is another form of insurance. If another investor is concerned that their shares may drop in value, they want to have a guarantee that someone will buy their shares at a specified price. If the shares drop below that price, the money they gave me requires me to buy their shares regardless of how low the price is on the contract end date. Of course, this is a higher risk and could result in an immediate loss in my investment balance. Therefore, I would never do this type of trade for a stock I wouldn’t have purchased anyway with a buy limit order.

The third type is one that I rarely do but it can be very profitable at a fairly low opportunity cost. It is similar to a covered call, but I pay another investor, up-front, for the opportunity to buy shares at a pre-determined price. In this case I am buying a call option. For example, I bought a call for 100 shares of Pfizer (PFE) that expired on October 29 at a price of $43. I paid $35 for this opportunity. If the shares traded above $43 on October 29, the person who sold me the call is obligated to sell me their shares for $43. This means, they have to sell if the price is $43.01 or any amount above $43. As it turns out, this worked in my favor. Otherwise, I am just out the $35. I did get the 100 shares. They are worth more than $43 now.

Success but Some Mistakes

I have learned a couple of new things during this year of trading options, so I will share those…

Know What is Happening with Your Investment

The first thing I learned is that trading options on a position that is about to execute a spinoff creates minor challenges. I learned Fidelity’s Active Trader Pro does not accurately reflect the true contract price if a spinoff happens. When REIT Realty Income (Ticker: O) spun off their office real estate to a new REIT (Ticker: ONL), I had one covered call for O pending. I did not want to own ONL, so I sold all of my shares. Shortly thereafter Fidelity called me to alert me to the problem. If the call was executed, I did not own the 10 ONL shares needed to satisfy the covered call.

After talking with a Fidelity rep, he concluded that my shares wouldn’t be called given where the share price was on last Thursday. However, he was wrong. The contract price for O had been adjusted, but the revised lower price wasn’t showing the new price in ATP. The shares were called. Monday morning, I bought 10 shares of ONL to take care of the gap. As it turned out, I was far better off to sell my ONL shares when I did, and rebuy them at a much lower price to meet the need. Lesson learned.

Focus on Big Fish Not Minnows

The second thing I have learned is that I can make more money in less time by focusing my covered call trades on some key positions. Furthermore, I often rebuy the shares the next week and repeat the trade. So, I have been doing more covered call trades on positions like AVGO, F, FLGT, HPQ, SAVA, STX, and QCOM. I do some cash covered puts, but I prefer cc’s as they don’t tie up my cash. Nevertheless, puts are sometimes a better option for me than buy limit orders because I get the cash even if I don’t get the shares.

A couple of months ago I thought I could generate about $50K in additional income buying and selling options in 2021. I underestimated the potential.  December may be a lean month for trades as my wife and I are taking our oldest granddaughter to Hawaii next month. I suspect I won’t be spending a lot of time trading options. But even if I stop now, we realized $70K more income from my options trades.

Dividend Income is Still King in our Investment Portfolio

Dividend Income

Dividend growth is still my primary investing strategy. The nice thing about that strategy is that it is practically set-it-and-forget-it. Good investments tend to provide more income year-after-year.