What About the Risks and More Requirements?

Part 5 – What about the risks and more requirements?

The good news is that you can manage the risks and there are just a couple of additional requirements you should know if you are going to trade options.

Therefore, we are almost to the point where I will start sharing some of my basic ingredients for a specific covered call option (CCO) trade. However, there are still a few preparations before we collect the option recipe ingredients to sell a specific CCO. Some of them are fairly simple, so I will start with some minimal requirements and then talk about the risks of trading CCOs.

Minimum Investment is Required: 100 Shares

You cannot trade options without owning 100 shares of a stock or an ETF. If I want to trade options in my Ford (ticker: F) investments, I will have to trade a minimum of 100 shares. Each option contract is for 100 shares. So, given Ford’s recent price of $11.20, I would have to have $1,120 invested in Ford to trade a single CCO contract. Obviously, many investors should think carefully about any investment they purchase. I would not buy an investment with the sole purpose of trading CCOs. However, you don’t have to have a ton of money at stake to begin trading.

We also own shares of Broadcom Inc. (AVGO), and those shares trade at $553.54. For each CCO contract, I am committed to a trade involving $55,354 of assets if I sell a single CCO contract. As you can well imagine, I did not start my options trading career trading AVGO. That was too much risk during my early learning stages.

My Trading History Involved Learning

I started slow and I started small. The first trades I made were in 2020.

1) In April 2020, I did three options trades. One was for AMD at $59 per share, the second was for GOLD for $27.50 per share, and the third was for KR (Kroger) at $33.00 per share. The net profit from those three was $658.52. As you can see, I had CCO trades on stocks with prices far less than AVGO. However, the profit from the three trades whet my appetite for future options trades. In 2020 I only did 24 options trades. It was a training wheels learning time.

2) In 2021, I started to experiment with more trades and different requirements. I did 816 trades and I continued to learn. However, in 2022 I did less than 550 trades because I refined my process even more to focus on maximum income with minimal effort.

3) Since I started in 2020, I have submitted 1,777 options trades. The income from those trades is just over $195,000. That averages $100 per trade. Each trade takes about five minutes of my time. A good portion of the $195K resulted from the 2021 trades, but with fewer trades I was able to increase the CCO income in 2022 to exceed $100K in additional income.

Not Every Stock or ETF Has Options

It isn’t hard to determine if a position trades options, but you need to know that you may hold stocks and ETFs that won’t give you options trading experience because some stocks are not traded in the options market. For example, GLAD (Gladstone Capital) does not have options contracts. Furthermore, some stocks and ETFs aren’t worth the time to trade.

I don’t want to lose some investments. I own many shares of ETF VYM, but I won’t trade options on my shares, even though I could. The reason is simple: I don’t want to be surprised by having my shares called away if the price rises above the CCO contract price. I did a couple of options trades on VYM, but determined it wasn’t worth the risk so I stopped.

The easiest way to find out if a stock or ETF is optionable is to use Seeking Alpha. You type in the ticker symbol and then click the “Options” tab. If you see Calls and Puts, then you can trade options on that investment. If there are no options, it will say something like: “There are currently no options for GLAD.”

While I have traded stock options and ETF options, I have no mutual fund holdings. I believe you cannot trade options on mutual funds. For example, there are currently no options for VIGAX.

How Big is Your Total Investment Portfolio?

Your IRA, ROTH and/or brokerage account size is a limiting factor. While it is certainly possible to begin trading options when your total account value is under $100K, I don’t think I would recommend more than a few trades per year. You also do not want to make trades that will hinder your diversification efforts. You can reduce this risk by using ETFs as the core for your total set of investments, and then allocate no more than 10-15 percent of your assets to potential options trades. It is unlikely that you can safely achieve $2,000 per month in CCO trades until you have built up your total portfolio to over $500K if you use a conservative approach.

Your Brokerage Trading Platform and Tools Matter

I like Fidelity Investments, but I do not use the Fidelity Investments website for my options trades. Trades can be done on their website, but I have learned it is far easier and faster to use Fidelity Active Trader Pro (ATP). The illustrations I will share in future lessons will show images from ATP.

Recommendation: Use Fidelity Active Trader Pro (R)

Two Major Risks Trading Covered Call Options

I think the word “risk” is probably too strong of a word, assuming you buy quality investments and are thinking long-term about your investments, including the ones you may want to use for CCO trading. The two major emotional hurdles are related to the upward or downward moves of the share prices and the craziness of bull and bear markets. When times are good, your shares can become more valuable than you thought they would be by contract expiration. The opposite is also possible: the prices of your shares drop precipitously before the contract end date. If the price skyrockets, and your shares are called away, you might have sellers’ remorse. You miss out on a gain you might otherwise have had if you had not sold a CCO.

The second risk is a bit more scary. If the price of your investment drops, you have no easy exit point because your shares are committed to an options contract. (There are tactics for dealing with this, but it can be disturbing if you don’t have a long-term perspective.)

Therefore, you should always remember that there are bull markets when stocks are going up, sometimes at a frantic pace. You should also remember that there are bear markets that can put a damper on your ability to sell CCOs that make sense for your long-term strategy.

Options Trading Crash Course

Sometimes it helps to read more in-depth explanations of the three potential results of selling CCOs. These three images cover the pieces well. I like the first two because they tend to be easy and require less emotional energy. I have experienced all three, and I have learned to be patient and think long-term when trading options and when buying investments.

If the stock increases in value…
If the stock value doesn’t move much you benefit in the best way possible.
Be prepared for surprises. One way to avoid surprises is to do a bit of homework before you enter a CCO trade.

Opportunities for Additional Learning

You may want to consider some Kindle books that focus on options investing. Here are three that I have purchased using my digital rewards from Amazon purchases: Options Trading Crash Course, Options Trading Quick Start Guide, and Covered Calls for Beginners.

Three Kindle Books

Scripture About Treasures and Trust

“In light of our frailty and limitations, how are we then to think about the future? James not only calls out our presumptuous thinking and planning, he also supplies the antidote. Very simply, we need to learn to make plans in humility, recognizing our complete dependence on God’s providential care. Nothing in the entire universe—including us—would continue to exist for one fraction of a second apart from God.” – Alistair Begg devotional The Frailty of Life.

Come now, you who say, “Today or tomorrow we will go into such and such a town and spend a year there and trade and make a profit”—yet you do not know what tomorrow will bring. What is your life? For you are a mist that appears for a little time and then vanishes. Instead you ought to say, “If the Lord wills, we will live and do this or that.” James 4:13-15

All scripture passages are from the English Standard Version except as otherwise noted.