My Rookie Season Writing Options: Third Inning - July Activity

 |  Includes: ACIIQ, MDT, MSFT, NOK, PCXCQ
by: J.D. Welch

No, you're not seeing things, and yes, the July 20th expiration date for options contracts hasn't rolled around yet. It's just that due to my meddling in my own affairs I don't have any more options contracts that will expire on the 20th of this month. For better or worse, I've taken a bit more of a proactive approach to trading my cash-secured puts and covered calls as part of my ongoing, on-the-job training in my rookie season of writing options contracts.

The Truth of It, Part 2

Those who read my first two articles on my rookie season writing options, one for puts and the other for covered calls, will recall the following Options Truth Table, which I created to help me sort out the double-negative context of buying and selling calls and puts:

During the past month, a new Truth revealed itself to me in a minor epiphany; that being that as the share price of a stock goes up, it may be advantageous to sell a covered call and, at the same time, buy back any cash-secured puts that now have a significantly lower premium than what I sold it for. And, the converse is true for both calls and puts. I've captured this New Truth in the following Options Truth Table #2:

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This may seem obvious to those who are more experienced at writing options contracts, but for me it was an eye-opening realization. I realized that, with a little patience and attention to the movement of my stocks' prices, I could close and then re-sell contracts during a period of time that I might otherwise have left the contract open and just waited for it to expire, and by doing so could generate more net income for my troubles than just "setting-and-forgetting" my options. Then, if the market cooperates, do it again; wash, rinse, repeat. This realization significantly affected the actions that I undertook in the last month, as the past month was quite a roller coaster ride for Mr. Market.

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July Puts

I ended up writing more cash-secured puts since the June expiry than I anticipated when I wrote my last article on my rookie option writing season. Too many, actually, as it turns out.

Still being bullish on coal, I wrote a put for Arch Coal (ACI) at the $7 strike price on June 20th and received a premium of $0.85 for a net gain of $84.27. Then on June 29th I wrote five puts for Patriot Coal (OTCQB:PCXCQ) at the $1 strike and received a premium of $0.15 per contract for a net gain of $72.12. As the month progressed, the market turned bullish on coal around the 4th of July. That's when I got a little crazy.

First, I decided that I didn't want to be put another 100 shares of ACI, and the premium on the contract I'd written had dropped to $0.30, so I bought back (closed) that contract on July 5th. The net result of these trades was a credit of $55.30 in my account, and I'd liberated $700 of my capital do deploy elsewhere. Not bad, so far, so good.

Next, on the same day, I decided to close my Patriot Coal (then PCX) $1 puts, since the share price of PCX had risen quite dramatically. Closing those puts at a premium of $0.08 per contract netted me $34.75 in the end. Still not too bad, this was all profit.

What I did next was the crazy part. I had come into a modest windfall of cash, and decided that I would take a calculated risk and, with the share price now around $2.47 and climbing, I sold some more PCX puts, four $3 contracts with a premium of $0.55 and five $2.50 contracts with a premium of $0.21. All of these contracts, however, were for the July 6th expiry, which had previously not existed, but became available sometime between the time that I'd written my original 5 puts for PCX back on June 29th (or, at least, that's what I recall). This endeavor netted me $320.06 in premiums, which I was prepared to put up against the actual assignment of the shares, which looked imminent, and reduce my cost basis.

Sure enough, the very next day PCX closed below $2.50 a share, and I was put the 900 shares come Monday morning. Do you know what happened next? Yup, later that day it was announced that PCX was going to file for bankruptcy. Oh, crap. That gamble, and it was a gamble, sure enough didn't pan out the way I'd hoped. In the end I sold my 900 shares of, what is now PCXCQ at $0.225 per share. Yikes. That little experiment with Patriot Coal cost me $1,893.70, an amount that I will file under "Education Expenses", and move on.

July Calls

As I reported last month, I did indeed sell covered calls for Microsoft (MSFT), Arch Coal and Nokia Corporation (NOK). However, not being content to let sleeping dogs lie, and armed with my newfound understanding of the possibility of "churning" calls to generate a marginal amount of additional income over the same period of time, I closed the MSFT and NOK calls for a modest net gain when their prices tanked on June 28th, then turned around and sold another call for MSFT the very next day when the market surged.

About a week later the market pulled back again, so I closed the open MSFT call contract and realized a net gain of $42.20; not bad for a week of just paying attention to the ups and downs of the market. When the market surged up again a week later, I sold another $31 call for MSFT, but this time at the September 21st expiration date, for a premium of $0.40. I have a limit order to buy back (close) this contract at the $0.05 premium, should the price drop again, which will result in a net gain of $33.25 for my troubles, and I don't have to pay close attention to the share price to try to "catch it" should the premium drop to that level. (Yes, insert your own axiom about falling knives here…)

I also sold four $2 Nokia calls for the August 17th expiry at the same time, for a premium of $0.16 and a net gain of $60.74. The way things are going for Nokia, I don't expect these shares to be called away, and should the price drop enough, I've got a limit order to buy back those contracts at the $0.03 premium. If that happens, I will end up netting $47.64, and will watch for the price to rise enough to justify doing the same thing again; wash, rinse, repeat.

Also, Medtronic (MDT) $40 August calls finally got to a premium I was happy with, so I sold a covered call for MDT at a premium of $0.42, and have a limit order standing by to close that contract should the premium drop to $0.06 a contract, at which point I will realize a net gain of $33.92. If the premium doesn't drop that low, I will just ride this contract until the August 17th expiry and hang onto the $40.94 that I've realized so far.

But what about Arch Coal, you ask? When coal stocks made a bullish run up in early July, I thought that this was the beginning of the bull coal run that I've been expecting, and didn't want my ACI shares called away, so I broke my own rule and bought back the four $7 call contracts for a net loss of -$184.92. I then sold four $9 ACI calls on the very same day for the $0.25 premium.

By July 12th that premium had dropped to $0.06 per contract, so I bought them back, and then sold four $8 October contracts for the $0.33 premium. The net result of all this activity so far is a positive $15.16, so I feel like I've redeemed myself for the panic closing of the $7 contracts in early July. At present I have a limit order to buy back these contracts at the $0.03 premium, which will just about wipe out my positive results, but which will allow me to start over and sell covered calls again for ACI and try to do better.

Bottom line, I'm up $221.46 in terms of calls for all the back-and-forth that I've done, but infinitely wiser in terms of how I'm going to approach selling covered calls going forward.

On Deck

At this point I'm out of options, so to speak. (Sorry.) I don't have any open puts, as there's nothing I really want to go long using a put selling strategy, and I'm saving my nickels and dimes for a bigger fish that I'm hoping will come my way. I've got everything I need to, want to and can in covered calls, and I'm just waiting and watching the market to see if there is another significant pullback that will trigger the closing of the calls I do have open. Then, it's wash, rinse, repeat, until next month.

Disclosure: I am long ACI, MDT, MSFT, NOK.

Additional disclosure: I am not a professional investment advisor or financial analyst; I’m just a guy who likes to crunch numbers and can make an Excel spreadsheet do pretty much whatever I want it to do, and I’m doing my best to manage my own portfolio. This article is in no way an endorsement of any of the stocks discussed in it, and as always, you need to do your own research and due diligence before you decide to trade any securities or other products.