The following is a guest post from Adam, a good friend and frequent contributor to the blog. Like many of us, he got bored during COVID and picked up some new hobbies. Being quite interested in the stock market, one of his hobbies was options. You may or may not be familiar with options, but they’re quite common in the stock market and are becoming more and more accessible for regular investors like us. Adam has gotten quite into it and wanted to share his experience so far!

First off, I am by no means a financial professional.  I’m just a guy who love investing, is very curious, and has a pretty good internet connection.  After COVID changed the way life was happening in 2020, I found myself with a lot of non-structured time, so I began checking off things I’d been meaning to learn about.  One of those things was options trading, something a buddy in my MBA program had mentioned off hand.  As I learned more about options in 2020, I began to dip my toe in the water.  The purpose of this post isn’t to teach you about options trading, but instead look at a specific strategy that exists within options trading that I have come to really love, the covered call.  

At the high level, a covered call is the process of me selling a contract to another investor for a premium.  An option contract is always executed in multiples of 100 shares. This contract that gives the buyer the right to purchase 100 shares of a stock from me at a predetermined price (strike price).  This is referred to as a “covered” call because I already own the 100 shares in my account.  An “uncovered” call would mean that I don’t already own the shares but am willing to buy them at the market price and sell them to the buyer at the predetermined strike price if the contract is executed by the buyer. The buyer of the contract believes the price of the underlying stock will increase over time, thus making their contract more valuable to resell or potentially execute in order to buy the 100 shares from you at the strike price.  

Here’s a “covered call” scenario to help add context. In this example, we’ll use YMF, but in this example imagine YMF not as today’s YoungMoneyFinance, but as a super large, publicly traded company. After researching YMF, you decide that the stock has some good long-term upside but will likely trade sideways or only slightly up over the next few months.  With this in mind, you decide to buy 100 shares of YMF at $10.00 (total investment = $1,000) on January 1.  Based on your earlier research you believe that the price of YMF won’t finish higher than $13.00/share on February 19^th. You are also comfortable selling your 100 shares if the price does go above $13.00 and the buyer decides to execute the contract.  Having decided you’re okay with the risks of selling a covered call, you take a look at the option chain for YMF and decide to sell 1 call contract that will expire on February 19^th with a strike price of $13.00.  The cost, or premium, for the buyer of this contract is $0.80/share, meaning the total premium you will receive as the seller is about $80 ($0.80/share * 100 shares/contract – any commission your brokerage charges).  As the seller, you get to keep this $80 premium no matter what happens to the price.  

Late last year, after having some good experiences with covered calls, I decided to perform a 12-month experiment where I set aside about $2,500 of my existing portfolio to see what type of return I could get using only a covered call strategy.  Now that it’s the end of February and I have 2.5 months of data to share, I wanted to share my results.

December 17^th, 2020

The first official day of my experiment.  I want to spread my $2,500 out on a few different stocks, so I did some research and landed on the following purchases:

I chose these 3 companies because they had a share price no higher than $5 and had pretty good volume, which would hopefully allow me to sell options more quickly and for a higher price.  

I then proceeded and sold the following calls:

Total premium I received on 12/17 was $112.06 with a total investment of $2,546.39, which equaled a return of 4.4%.

December 31, 2020

During the month of December, the price of RIG fell effectively rending the RIG calls I sold worthless.  Because of that, I was able to buy the calls back for $1/call (profit of $4/call) and then resell new calls further out.  This is what’s known as “rolling a call”.  I sold my RIG calls in two batches:

At the end of December, my results looked like this:

My total return on the initial investment was -6.54% due to falling stock prices since I purchased them, but I had received a total premium of $128.64 since 12/17, which is a return of 5.05%.  I didn’t reinvest any of that premium in December into any other stocks, so it just sat as idle cash.

January 31, 2021

The price of RIG rose in January, ending at $3.28/share on January 15.  This meant the owner of the 4 calls I sold exercised the options and I had to my 400 shares to them for the previously agreed upon price of $3/share.  If you sell a covered call, you will likely see somewhere posted that the potential loss for you is “unlimited”, which is scary!  But this is what they’re referring to.  Technically, I lost out on $112 of profit because I sold them for $0.28 less than market value (.28*400 shares = $112).  But I initially bought the shares at $2.555/share and had earned $35.41 in premium by selling covered calls which brought my adjusted cost basis down to $2.47/share, so I was still profiting by selling at $3/share.  Proceeds from the sale were $1,199.97 – $1,022.00 (initial investment) + $35.41, so I earned a total of $213.38 from owning RIG or a return of 20.88% with a return of 3.46% off premium alone.  I took the proceeds and reinvestment them in the market by purchasing 400 shares of GNW.  My WWR and WTRH calls expired worthless, so I was able to keep those shares and resell covered calls on them.  I sold the following calls in January:

January wrapped up with the following numbers:

Because of rising stock prices, my return at the end of January was 18.7% overall, and I had received a total premium of $229.73 since 12/17 for a return of 9.02% from premium alone 

February 28, 2021

WWR finished Feb 19 at $7.78/share, which meant I had to sell them for $7.50/share, meaning I missed out on a total of $28 because of the call I sold.  I bought WWR at $5.09/share and had made a total of $90.56 in premium bringing my adjust cost basis down to $4.18/share.  Proceeds from the sale were $749.98 – $509.39 (initial investment) + $90.56 meant a total gain of $331.15, or 65%.  A majority of that was due to gain in stock price, but I did earn a return of 17.78% from the premium I received.

I decided in February to start putting some of the idle cash I had earned from premiums to work by reinvesting.  I first bought 100 shares of DNN at $1.355/share.  I then sold 100 shares of GNW, took the proceeds from that sale, along with the WWR sale and the remining cash I had and bought the following:

I sold the following calls during the month of February:

Admittedly, I did leave a little premium on the table by not selling any covered calls against my 300 WTRH shares.  They are scheduled to report earnings in early March, and that event will usually drive up the cost of a call.  I’m hoping that by waiting until closer to the earnings release date I can sell a call for more premium than usual.  Here is how my account looks at the end of February.

After 2.5 months of this experiment, my total account value has grown by 21.04%.  The total amount of premium I have received in that time has been $386.28, or a return of 15.71% on my initial $2,546.39 investment.  

Stay tuned as I post quarterly updates of my results, as well as pros and cons I learn along the way!

YMF’s Comments

A big thanks to Adam for sharing his story with us. Admittedly coming into this I kind understand what options were, but felt they were a bit too out of my league to try out. I often learn best from examples, and this was super helpful for me to walk through. I’ve asked Adam to come back in a few months to continue sharing updates but hey, a 21% return, which would have only been 6% without doing options isn’t a bad return for 2.5 months!

About the Author

When Adam isn’t using his great internet connection to research option plays, you can find him, his wife, and their puppy enjoying all that Atlanta has to offer.  Adam also recently founded an executive coaching firm, Martin Growth Partners.  If you are interested in learning how coaching can help you become your best self, regardless of job role, please reach out.  He’d love to chat!