Today I sold 2 option contracts in an attempt to add some more income. The first contract that I sold was the BAC Jan 18 2014 $7 Put for $1.73. If the option gets exercised then my cost basis for this transaction will be $5.27. If the option expires then I will pocket the $173 less commission for the option. I figured that since I would be a buyer of BAC on a dip down into the $5 range it made sense to get paid to wait for that price. If put goes unexercised then I will earn $173 less commission on the $700 that is committed to this order which works out to a 23.47% total return in about 23 months. That gives me around an 11.37% CAGR on the money while I wait. Considering I'd be happy either way this trade works out it made sense to make the trade.
The other contract that I sold was the HAL Jul 21 2012 $42 Call for $1.60. Thanks to my ESPP I was able to purchase these shares for a cost basis of $29.33. There's 3 things that I look for when selling covered calls with a 4-6 month expiration. (1)Premium yield - the percentage of the amount you are paid divided by the option exercise price. I target a minimum of 1.5% on my premium yield.
(2)Margin of safety - (Premium + Dividends Rec'd) / Current Price. This is the downside protection that the shares would have to drop to counteract the premium you receive. I target a 4% margin of safety.
(3)Upside Profit - (Premium + Dividends + Strike Price - Current Price) / Current Price. This is the amount you would make if the option is exercised on the expiration date. I target at least a 6% total upside.
Here's the numbers for the HAL Call that I sold.
If the option expires I will receive just the premium yield which works out to a 7.98% CAGR. The margin of safety for this trade I'm not too worried about because ideally the option won't be exercised and I can keep the shares to avoid the Disqualifying Disposition effect from the ESPP. The upside profit is great being another 19.53% higher than if I sold out now. Based on the purchase price of the shares my payout would be a 49.3% gain. I'm hoping for the option to just expire and feel that it very well could. The stock has to have a 15% move up from current prices to reach the strike price.