Note: This article is part four in our series on alternative income strategies. Please also read:
- Part I: The Single Best Method For Collecting Investment Income
- Part II: 3 Examples Of Collecting Income on Bullish Stock Ideas
- Part III: A reliable Strategy For Generating Extra Income From Your Stocks
In our last installment we discussed a strategy for collecting extra income from stocks already in your portfolio. This strategy involves selling call contracts for stocks we own.
By selling these contracts, we are agreeing to sell our shares at a specific price (provided they are trading above this level in the allotted time. We are also getting paid to enter this agreement (and this payment represents the income from this strategy).
Several of you asked for specific examples of this income strategy in action. So today, we're going to review a few actual trades that I have recommended to subscribers. These real-life trades are taken from our premium trading service which you can subscribe to via Seeking Alpha's marketplace here.
If you're not familiar with this approach, I suggest you read our previous article before reviewing these trades.
Income Example #1: JA Solar
My first example comes from an income opportunity I recommended for JA Solar (NASDAQ:JASO). This stock had excellent prospects thanks to strong global demand for solar energy in the second half of last year.
The trade started by selling September put contracts for JASO and collecting $0.55 per share. (Remember, each contract represents 100 shares, so I received $55 less commissions from selling these put contracts).
When the put contracts expired, JASO was trading below the $8.00 strike price and so I was required to buy shares at $8.00. Here's what the stock looked like on September 18 when the put contracts were exercised:
After purchasing shares of JASO, I recommended selling the October $8 call contracts which were going for $0.25 per share. By selling these call contracts I was agreeing to sell my shares of JASO at $8.00 (the same price as my purchase price). Since I was paid $0.25 per share (on top of the $0.55 per share from selling the put contracts), I was locking in income for entering this agreement.
Over the next few weeks. JA Solar traded higher and on October 16, the stock closed at $8.69.
Since JASO closed above $8.00, I was required to sell my shares at $8.00. This is the agreement I entered by selling call contracts.
The benefit of this trade is that the income I received from selling put and call contracts added up to more income than I would have received if I had bought JASO at $8.00 and sold on the date the contracts expired. The added income was captured by selling put and call contracts.
Income Example #2: JetBlue Airways
Next, let's take a look at a situation where a stock I held traded sharply higher after I sold call contracts...
On June 19, we bought 400 shares of JetBlue Airways (NASDAQ:JBLU) in our model account after our June $21 put contracts were exercised. We had sold the June $21 put contracts for $0.55 per share, giving us $55 for each contract we sold - or $216 after commissions for a block of four contracts.
The shares were bought automatically. This was because we sold June $21 put contracts and when the market closed on June 19 (the day our put contracts expired), JBLU was trading below $21. Here's a chart of what JBLU looked like at that time:
I was happy to own shares of JBLU because I believed that low fuel costs would help send shares of the stock higher. Still, I wanted to generate extra income from my shares. So I elected to sell call contracts for my shares.
Remember, when we sell call contracts, we're agreeing to sell our shares of stock at a specific price - so long as the stock is trading above this price point when the call contracts expire.
For JBLU, I elected to sell the July $21 call contracts. This way, I was agreeing to sell shares at my exact purchase price. The July $21 call contracts were trading at $0.77 per share when I sold them, which meant that I received $77 per contract (or $304 including commissions for a block of four contracts).
Over the next few weeks, shares of JBLU traded higher as expected. The July call contracts expired when the market closed on Friday July 17. At this point, shares of JBLU had closed at $22.94.
Even though JBLU was trading well above my $21 purchase price, I was still required to sell my shares at $21. this is because by selling the call contracts, I entered an agreement to sell my shares at $21.
If I had held my 400 shares from $21 to a price of $22.94, I would have an unrealized gain of $776. (A gain of $1.94 times 400 shares equals $776). But instead I sold my shares at a breakeven price of $21.
I still made money on the shares thanks to the $304 I received from selling call contracts. But by selling the call contracts, I capped my potential gains that I could have received during the time I was waiting for the call contracts to expire.
That's the way this strategy works. We give up some of our potential gains in return for guaranteed income when we sell our call contracts.
Now let's take a look at a third income opportunity - this time, one that traded lower after I sold call contracts...
Income Example #3: The Blackstone Group
So what happens when a stock that you have sold call contracts against trades lower? In this example I want to explain how selling calls can help to reduce your risk of losing capital as stocks trade lower.
On December 18, I bought shares of The Blackstone Group (NYSE:BX) automatically as my December $30 put contracts were exercised. At the time, Blackstone was trading at $29.60 and since the stock closed below the $30 strike price I was required to buy shares at $30.
Blackstone is a top-tier private equity group that continues to raise assets and should find many attractive investment opportunities as markets become more volatile. But investors have become fearful that Blackstone will not collect performance fees with market prices lower. And so shares of Blackstone have trended lower.
After buying shares at $30, I recommended selling the January $30 call contracts. These contracts were trading at $0.99 per share allowing us to collect extra income from selling these call contracts.
When the call contracts expired on January 15, Blackstone had fallen to $24.56.
Obviously it was disappointing to see our shares of Blackstone drop by $5.44 from our purchase price. But thanks to the income we received -- first from selling our put contracts, and then from selling January call contracts -- our unrealized loss was paired down to $3.70 per share. (We received $0.75 from selling our put contracts and another $0.99 from selling the call contracts).
This example goes to show two things:
First, this is not a "silver bullet" or "perfect" trading solution. You're not guaranteed to make money by selling put and call contracts.
Second, this method of trading can make a material difference in reducing potential losses if stocks move against us. That's because the income we receive can offset much of the stock price movement.
Hopefully these examples have been helpful in explaining the benefits and the limitations of this strategy. In our final installment, we'll look at some of the more specific guidelines that I recommend when selling put and call contracts for income.
Disclosure: I am/we are long BX, JBLU.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: We own a covered call position in BX and JBLU as part of the Growth Stock Income Generator model portfolio.