This trade was inspired by my fellow blogger Integrator from the blog Get financially Integrated! and his latest article at Seeking Alpha “My Dividend Portfolio: Evaluating AT&T“. He is evaluating the AT&T (T) stock in his article concluding that the stock didn’t drop low enough for him to be buying this stock although the recent decline in price made this stock interesting already.
I commented under his post that he can be selling some puts against T to get a better price. And then it hit me, that I can actually do it as well. I have enough reserves to take this trade and collect some put premiums before I get assigned.
(MORE: Dividend Update – November 2013)
So this trade was inspired by Integrator and this morning I opened a new trade – AT&T put selling. This trade is also a part of my ladder strategy I decided some time ago to create.
Two types of ladder
There are two types of an option ladder an investor can create. One type is a time ladder and the other is a strike ladder.
Options time ladder
A time ladder means creating a ladder of options contract spread in time. You start selling put options with different expirations. It is a strategy I am going for. I try to sell a put contract with expiration every month and as the options expire (or get assigned) I will just roll the option into the next month. For example if my January 2014 contract expires worthless, I will just open another one in the next free month – which is June 2014. See my Calendar below:
As you can see, my next free month is June 2014. If my Safeway (SWY) trade expires worthless (or gets assigned) in January 2014, I will sell another put with June 2014 expiration.
So I am creating a time ladder. And with this type of a ladder I can use any underlying stock I want which sort of reduces the risk.
Options strike ladder
This is more known type of a ladder. You use one underlying stock but you sell several puts with different strike prices. If for example AT&T currently trades at $34.40 a share you can sell 10 contracts at 34, 10 contracts at 33, 10 contracts at 32, and 10 contracts at 31 strikes:
Ideally you want to sell those strikes circa 1 – 3 months expiration, but no longer so you have time available for rolling the ladder. As the underlying stock rises up in price you start buying back the lowest strikes as their price declines to a very minimum. The reason for buying them back is that you want to release the lowest ladder rungs in case the stock drops back down, so you can sell new puts there.
If the stock starts declining you want to be closing the upper rungs and selling the lowest rungs to offset the closing price of the upper rungs (and of course you want to start selling longer expiration time in this case as the lower rungs will be less expensive than the higher rungs.
This type of a ladder is financially extensive. You need enough free capital in order to create this ladder. You will be selling multiple contracts and you need enough cash for maintenance. Thus I am not interested in this type of ladder at this time. Maybe in the future when my account grows and I have more available cash.
AT&T new put selling trade
So today I opened a new trade:
12/10/2013 10:31:41 Sold 1 T Apr 19 2014 34.0 Put @ 1.39
With this trade I received a nice premium of $130.21 (after commissions) and my cost basis for AT&T holding dropped to $32.16 a share. That makes my position 6.35% in profit although the stock was declining recently.
If you want to mirror this trade, you still can open it as well. You will probably collect a better premium than mine. You would probably collect $154.00 premium before commissions.
(MORE: Stock Bought: ARCP)
There are three outcomes with this trade:
- The underlying stock will end above $34 strike price at expiration. In that case the option expires worthless, I keep the premium and will be free to repeat the trade with the same money.
- The underlying stock will end below the $34 strike price at expiration and I decide to get assigned with 100 shares of AT&T at $34 a share (minus the premium). I will be free to repeat the trade and sell another put contract with a new money.
- The underlying stock will end below the $34 strike price at expiration but I might decide not to get assigned with 100 shares and roll the contract further in time and lower strike.
If you want to play this trade safely, you can open a contract at 33 strike (receiving 4108 premium) or 32 strike (receiving $75 premium) to avoid assignment.
Or you can just enjoy reading this post and opening no trade.
Do you use options in combination with dividend investing to boost your income and lower your cost basis or you believe this is an extremely dangerous strategy and stay aside? Share your thoughts as I like to learn from it.