This is a very interesting concept shared by one of most favourite YouTubers, Ken aka Chicken Genius Singapore. Essentially, this method allows you to earn 26.6% returns in a single year, based on a single trade. This is a very good return and beats the S&P500 average returns of 8 to 10% per annum. Imagine the time saved doing trading every day/ night trying to get close to this goal, when you can do everything in a single trade.
How It Works?
This method involves selling an ATM PUT options, with an expiration date 1 year out. In this example, Ken sold a PUT option on his highest conviction stock, Telsa, with an expiration date of 20 Jan 23 (1 year later), a strike price of $1000 and collected a premium of $266 for the contract, which is 26.6% of $1000. By 20 Jan 2023, if Tesla rises above $1000, the contract expires worthless and he can go on to sell another PUT contract with the money freed up. If Tesla drops below $1000, he will buy 100 units of Tesla at 1000 each. However, his average price will be $734 ($1000 – $266).
Points To Ponder
There are some points for consideration with regards to this method.
If the share price drops below $1000, then the overall returns will not be 26.6% anymore, as there will be some paper loss incurred by the seller, who now must own 100 units of Tesla shares. For example, if Tesla closes at $900, there will be a 10% paper loss. Thus, the overall gain reduces to 16.6%.
The percentage of returns is high for a high IV stock like Tesla. It means prices could fluctuate up and down quickly. Therefore, there is a certain level of risk involved, or rather a higher risk, when trading options on a high IV stock.
Also, there is a limited upside as the maximum return is the price of the premium. If Tesla goes up to $2,000, the returns will still be 26.6% instead of 100%.
This is a trade that requires high capital as each cash-secured PUT contract will require $100,000 of collateral set aside just in case the contract gets exercised on expiration.
However, if you are a Tesla bull/ fan and do not mind owning Tesla at a discounted price from its current price, you can consider selling an ATM PUT option and follow this method. Your average price of Tesla, when the PUT contract is exercised at expiration, will be much lower as compared to you buying 100 units of Tesla shares now. If all goes well, you will get 26.6% annual return when the contract expires worthless.
There is another way to profit from this trade if the share price of the underlying shoots up way above the strike price. You can choose to close the contract by buying the PUT option contract. In this way, you lock in your profits and free up the cash set aside for this contract, way before the contract expires, just like what I did in this example, where I close 2 Tesla PUT contracts in 2 consecutive days.
In conclusion, you can explore this method of selling ATM PUT with 1-year expiration on your favorite stock, at the strike price/ average price that you do not mind owning the stock at, and get a pretty decent return out of it.
The Newbie’s Guide To Options Trading
How does PUT Option Works?
What Is Implied Volatility (IV)?
Why Are CALL and PUT Options Commonly Known As Covered CALL and Cash Secured PUT?
What Is In-The-Money (ITM), At-The-Money (ATM) And Out(of)-The-Money (OTM)?
How I Made USD$9,827 In 3 Trading Days Using The Easiest Option Strategy
4 Reasons To Close An Options Contract And How To Do It