by Ruth
Sell Call Options to Sell Stocks.
Last week I discussed how to sell a put option (PUT) to buy a stock. Although I highly recommend using the “sell-puts-to-buy-stocks” strategy, I must caution you about selling a call option to sell a stock.
Like a put option, a call option is a contract that gives the option buyer the right to buy a particular stock from you (the option seller) at a predetermined price known as the strike price, within a specified window of time. To induce you to sign the contract, the buyer will pay you an option fee, the premium, right now (i.e., the moment you sell the call).
I mentioned before that I was forced to buy a stock at $31 when its price fell to $23 in March 2020 because of COVID-19. After selling six rounds of put options with a cumulated premium of $8.5 per share, my actual cost to buy the stock is $22.5 per share, and this stock pays a decent dividend. Recently, the stock traded at around $36.
Should I sell? What do you think?
My answer is: It depends.
As an investor, generally I try to own my stocks for as long as possible, especially if the stock pays a good dividend. Under certain circumstances, however, I may need to rebalance my portfolio and will consider selling a stock.
For example, I used to work for a pharmaceutical company and received a lot of stocks as a portion of my compensation. Suddenly, I realized 50% of my entire portfolio was on that stock. Therefore, I had to diversify to reduce my exposure to risks. Let’s assume that the stock price was $120. Instead of selling that stock outright, I sold five options at a strike price of $120, with a target time of one month. The premium was $3.4 per share. One month later, the stock went up to $122 per share. I was forced to sell 500 shares at $120. However, I actually sold it for $123.4 per share.
It sounded good. The problem? That year, the capital gain put me into another tax bracket.
I would emphasize again that everything, including my life, is entrusted to me temporarily. My responsibility is to obey and be a good steward according to God’s guidance. After paying a hefty tax bill that year, the Holy Spirit reminded me that owing a lot of tax because of poor planning wasn’t a good use of the assets that God has entrusted me. Later, I found a better way to rebalance my portfolio: Donate the stocks to my church or nonprofit organizations of my choice.
To some of you who don’t usually itemize but give regularly, please consider setting up a donor-derived charitable fund and make a large sum of donations, and you’ll receive a tax deduction in the current year. You can then donate out of that fund over time in the next few years.
Additional Notes on Execution.
First, to trade options, you’ll need to open a brokerage margin account. With a margin account, you can borrow money to invest in stocks. But please don’t borrow any money for your investment. Only invest in the stock market when you have extra, dispensable cash.
Second, I mentioned my finance professors’ comments before and would like to reiterate it: The US market is very efficient. When a piece of news reaches you, likely most people have already learned about it. Thus, don’t believe what others tell you about which stock or option to trade. Do your research and draw your own conclusion. You can read and study what others have to say about your chosen stock/option of interest. Yet take those opinions with a grain of salt.
Third, I’ve also talked about my professor’s other advice. At any given time, the pool of money is fixed. When one person loses money, it goes to someone else. If you want to make money, figure out who constantly loses money and do the opposite.
Trading option is trickier than stocks because of the time element. As you buy a stock, you own a piece of that company, and your ownership won’t expire until you decide to sell. Options are different because it’s not ownership but a contract. When the time is up, the option becomes useless.
Many online sites advertise you can achieve a weekly return of 5% by trading options (mainly from buying them). Yet, according to the stock platform Etoro, 80% of day traders lose money over the course of a year with a median loss of 36.3%. The Wall Street and other sources estimate that 90% of investors lose money buying options.
It’s a fact that most people who buy options lose the premium at the expiration of the contract. To make money, do the opposite and sell options.
Fourthly, don’t be tempted to sell naked options (i.e., selling a call option without owning the shares, or selling a put option without cash to fulfill the obligation at the option’s expiration). It’s against the principle of balancing risks and returns.
Even though different option trading strategies (e.g., butterfly spread, straddle…) look alluring, I stick to my approach and use options as a tool to buy and sell stocks. Thus, for put options, I set aside cash in preparation to purchase the stock of interest should its price fall below the strike price in my sold option. And I only sell covered calls (i.e., selling call options on the stocks I own).
I remember one time I shared my tips with someone at church, and a month later, he reported back to me. “Your strategy doesn’t work. I was forced to borrow money to buy 1000 shares of XXX stock.”
I replied, “I’ve never borrowed money to buy stocks.”
The same individual later made another mistake. “I followed your strategy and sold three contracts of puts to buy ZZZ stocks. Guess what? I’m now stuck with 300 worthless shares.”
I challenged him. “Did you research ZZZ and concluded you truly wanted to own a piece of the company for the long run?”
He scratched his head. “A friend told me ZZZ just discovered a big gold mine in Africa. I thought it was a good bet.”
Well, don’t bet. Do your analysis and be a trustworthy steward of whatever God has entrusted to you.
