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Reducing Cost Basis with Covered Strangles: An Example

Let’s continue our series on cost basis reduction with the same example I showed previously on Cardnial Health stock ticker CAH. As you recall I only sold calls in the last exmple. Today I’m using the exact same timeline same stock, we are just selling a put as well as the call to compare the difference in cost basis reduction of selling calls and selling strangles. Full disclosure I did not sell strangles against this position in real life, I just sold the calls, so this is hypothetical but still very informative.  As we discussed last time selling strangles adds additional risk which increases your reward but also increases your possibility of losses. We already know that CAH was very bullish so selling coverage strangers is going to look like the best strategy using hindsight. If the stock went down this example would look different.

 

So once again we bought CAH off the red line (Yes, trading can be this simple). 100 shares a 69.50 we collected the dividend of .50 a share a week later making our cost basis $69 a share This is the power of dividend stocks. Read my entire series on them!






Remember a covered strangle is selling a call and a put around your shares, so instead of just selling a call, we're going to sell a put as well.


Look at the chart below. The purple line is the strike of the covered call. Do you see how it's above the 100 moving average (the blue line)? Do you see how the covered call is at resistance, how all those previous candles stopped around $80? Let's agree to sell our shares there!


Now look at the orange line, this is where we'd sell a put which obligates us to buy more shares. Do you see that's where we bought the stock originally? Do you see how we just setup an agreement to buy on the red line again? But this time someone is paying us even if it doesn't hit that red line through the premium I received.


This is what the option chain looks like.

The red squares show the delta, and the place we'd click to sell each option. We are looking for a 20 or 30 delta strangle.We are going to sell the 80 call for $1.15 just like I showed last time, BUT we’re also going to sell the 70 put for $1.20. So with this options trade we are effectily agreeing to sell our shares 80 and we are agreeing to buy more at 70, we collected $2.35 in cost basis reduction. Someone paid us 235 to obligate us to sell high or buy low for the next 50 days!


The covered strangle doubled our premium received from the covered call example! Keep in mind more risk gave us more reward.


CAH continued to run, the covered call part of the strangle was being tested the entire time. but with a stangle when half of your strangle is being tested the other half is winning! So as my 80 CC is being tested, the 70 put is 100% a winner. This is the chart:



Earnings are coming up soon. This is my rule, you don’t have to do this, but you can avoid a LOT OF PAIN if you decide to avoid undefined risk over earnings, especially if you can get out for a win! So as CAH had earnings coming up I closed the short put. Lets look at the options chain so I explain my decision making process.



The put option we sold for $1.20 is trading at $0.15. That means I can buy that option back and lock in $1.05 in premium and cut ALOT of risk. If CAH drops, I can always buy more shares or I can sell another put! This is an easy descision for me. Its not worth $0.15 or $15 to keep that put open.


As CAH dips on earnings we have a new opportunity we did NOT have with just the covered call. We can move our covered call from 80 to 85 for a credit if we start a new covered strangle! This is the chart. Do you see how CAH touched the green line which is the 50 EMA? Moving averages are SO important to me. Read about the power of Moving Averages


Of course, you have the choice to sell another put and make another strangle or just keep rolling the covered call. The decision is something you need to decide based on your timeline and account size. When a stock makes a big run it's fine to let the shares go.


A 20-30 delta strangle is awesome for reducing cost basis if you are willing to hold the stock long term this is what it would look like to enter another strangle.



So instead of just rolling the covered call if we start another strangle we would collect a .50 credit to agree to sell our shares at 85 (instead of 80), so a gain of 5.00 a share or $500! if you agree to buy more shares down at 75. More risk, more reward!

 

This is what it looks like on the chart.



Do you see another strangle is just agreeing to buy more CAH off the red line?? I'm going to stop this example now, but as you see CAH keeps running. You can keep doing this repeatedly. I would stop doing this when a stock starts making new highs look at the weekly or monthly chart to see this . Eventually stocks pull back. It might take a long time or it could be sudden, so part of selling high means you actually need to sell your shares! You can always wait for a pullback to start another position.


Covered strangles are a very powerful options trade to reduce cost basis when a stock is bullish or trading sideways. The power of the covered strangle is you have a bullish and bearish position around your shares so when a stock does take a temporary dip the covered call helps further reduce your cost basis. When the stock takes off bullish your short put helps you collect more premium. It’s like double dipping, but you need to understand the additional risk of course.

 


I hope you enjoyed this example. I know this was a long example, but I'm giving you years of experience and a lot of education I paid a lot of money to learn. 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!






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