Continuing the series on reducing the cost basis with an example! Last week we discussed covered calls. If you haven't seen the previous articles we've already covered why reducing your cost basis is essential and discussed a straightforward method for determining where to buy shares.
Let’s get back into the example.
I owned 100 shares of CAH, remember I bought it off the red line at 69.50 a share. About a week later I collected a dividend of .50 a share. This means my effective cost basis is now $69. In the chart below you can see I sold a covered call using the logic I shared above. This is my actual trading plan. Look at the graphic below:
Below is the premium I collected. The graphic below is an options chain. It looks super complicated. Don’t worry I felt like I would never understand this either. It’s really not that bad. I’ll do an article on this soon. Just focus on the red squares for now. The red square on the right is the price I’m willing to sell my shares (80) and the red square on the left is what you click to actually sell a call. I collected $115 which is the middle of those two numbers. This means I just reduced my cost basis by another 1.15
I’m agreeing to sell my shares at 81.15 (the strike of the call plus the premium collected). You are about to see what happens with a covered call goes ‘wrong’ in terms of capping my upside. But you will also see how I generate income.
As you can see below CAH kept moving up, past my covered call. The purple line is the covered call I sold. Do you see how CAH went below the purple line? I had an alert to notify me, so I didn’t have to watch the chart!
I figured that unless there was a trend change my shares are about to be gone before the next ex-dividend date. If you have a call in the money on the ex dividend date you will likely have your shares “called” away early. Because the person who bought that call you sold wants to collect the dividend, by converting the calls to shares!
So when my covered call went out of the money I decided to roll this for a credit. I roll for credits to keep reducing the cost basis!
I had the 80 May Call, I rolled it out to June, the options chain is below. So I closed the current covered call, by ‘buying it to close.’ I then sold the June Call. I closed the may call for $1.50 and I sold the June call for 3.00. So once again I reduced my cost basis by 1.50. That is 3 dividends!
The options chain is below:
Look at the chart below. My June call was deep in the money. Meaning the stock is trading at 85, and I sold the 80 call. I knew my shares would get called away on the ex dividend date.
So what I did was roll out my covered calls one more time, I collected about 1.00 which was again another 2 dividends!
So this is an example of where I capped my upside on the 100 shares. I could have sold the shares at 94, but you never really know if a stock is going to go straight up. I made $365 on the covered calls and $50 on the dividend.
Next time lets look at another options strategy I love to use to reduce my cost basis: covered strangles. If you want more information you should join the GKT discord to discuss these tips in more detail and connect with like minded people who trade the stock market! Happy Trading Good Kids!
Disclaimer: this is NOT financial advice. I’m basically just some dude on the internet who’s been trading a while, and I use the stock market as my primary source of income. None of this is financial advice it’s purely educational!