Nearly all of us understand the concept of becoming a Landlord don’t we?
You buy a property (hopefully in a growth area) and you draw up a lease agreement with someone who is prepared to rent the property from you for a premium, or rental fee each month.
As a property investor, your intention would likely be to hold the property while it goes up in value and in time you would make some capital growth while the rent you receive contributes to your income. Of course, if you are a smart investor, you would make sure your property was insured against damage to protect your invested funds.
Do you realise you can do exactly the same thing using shares, only now you would become a ‘share lord’ instead.
This is a low risk Option Trading Strategy called ‘The Protected Buy Write’ and it has made many people we know very well off (ourselves included).
This strategy is a combination of Stocks and Stock Options that allow us to benefit from 3 key areas using just a few simple steps.
1) Insurance
2) Capital Growth
3) Income
- The first thing we need to do is decide which shares we are going to purchase or perhaps we already own a parcel of shares over which we can write Call Options. A Shortlist of Liquid Optionable Stocks will make our selection process easier.
If we are applying this strategy on the Australian Stock Market, we need a parcel of 1,000 shares and if we are dealing with the U.S market, we need a parcel of 100 shares.
- Before we buy any stock we take out an insurance policy to protect us against a fall in share price. For this we purchase Put Options because they give us the right to SELL our shares at a fixed price anytime throughout the life of our insurance ‘policy’
- Once we have our insurance in place, we phone our broker and place an order to buy the parcel of shares. You could use an online broker if that is your preference. This is entirely up to you.
- Our final step is to sell or ‘write’ a Call Option contract over our shares.
When we purchase Call Options we have the right to buy the underlying shares at the agreed strike price, but we are under no obligation to do so. We pay a premium for this right.
However, when we sell (or write) Call Options over shares we own, we are obligated to sell our shares to the option buyer at the agreed strike price if they exercise their right. Our reward for this obligation is the Call Option premium which we get to keep regardless of which way the share price moves.
Our written Call Option Contract is effectively our lease agreement and our ‘tenant’ is the option buyer who pays us a premium which is effectively our ‘rent’
We are now a ‘share lord’.
Let’s walk through an example of this:
We have decided to purchase some shares that are currently trading on the market at $ 20.50…..
1st Investment Key: 
Insurance – Put Options
We buy 12 month dated Put Options with a strike price of $ 20.50 and for this we pay
say $ 2.20 in premium
2nd Investment Key:
Capital Growth – Share Selection
We buy the shares for $ 20.50
3rd Investment Key
Income – Call Options
We write Call Options with a $ 21.00 strike price one month to expiry and we receive say $ 1.50 in premium
Let’s Understand the Strategy
We paid $2.20 for the Put options for a 12 month period (similar to car insurance premium) so our maximum potential loss is the cost of our insurance policy rather than the full share price.
Writing the Call Option provided $1.50 of income so within 2 months of implementing this strategy, our insurance cost is re-paid leaving the following 10 months until expiry to enjoy the regular profits.
What Happens if the Market falls?
Our shares are INSURED by the Put Option, so we can always sell them at the price we initially paid for them or we could sell them at market price, and hold the PUT option as it would increase in value while the share price falls.
Once the market has settled we could sell the Put Option for a profit and we also then have a GREAT opportunity to purchase the shares at a cheaper price and repeat the strategy again.
What Have You Got to Lose?
The appealing part of the protected buy write is that no matter which way the share price goes, you are smiling J
If the share price rises above your written Call Option strike price and you have to sell your shares, you stand to gain on the capital growth as well as the call option premium received.
If the price moves sideways and your shares are not ‘called’ away form you, you get to keep the premium and your shares to repeat the strategy next month.
If the share price falls, you can exercise your Put Option and sell your shares for what you paid (no loss) and you get to keep the Call Option premium.
Related posts:
- Option Trading Strategies: Protective Put When an investor purchases a put option and they own...
- Option Trading Strategies: The Long Call Option Trading Strategies such as the Long Call (Buying Call...
- Understanding the Advantages and Disadvantages of Options for an Effective Option Trading Strategies by: Daniel Webb This article looks at the potential advantages...
- Option Trading Strategies: The Long Put Option Trading Strategies such as the Long Put (buying Put...
- Put Options Used In The Collar Strategy Can Protect Your Stocks Hoping and praying that the stocks that you just bought...
Related posts brought to you by Yet Another Related Posts Plugin.
