We’ll be selling another covered call today in our ongoing wheel of fun put trade that we started back on Mar. 8, 2018. As it turned out this trade is a perfect example of why I love option trading and why I believe that everybody’s portfolio could benefit from a little bit of options exposure. There’s many reasons for this, I could do a top 5 or something in the future but for today let me just highlight this one reason.
We can turn a profit even when we’re wrong
Recall from the accompanying video on how to use a stock screener, I went over the reasons why I felt CVS Health Corporation was a little undervalued and was a good target for this trade. At the time I said that it was trading at about 68.20$ which was about as low as it’s been since 2014.
For the vast majority of investors, when they identify a stock that is undervalued they buy it and then basically sit on it for a while and see if they are right. They will likely use a stop-loss and probably also have some kind of price target in mind for when to sell it for profit, but generally speaking it’s a buy and hold investment with the only chance of making money happening if the trader is right on price direction.
If you buy a stock, you can only make money if you’re right
Well in my case, at least as of today I would say I was wrong on price direction right? It’s currently trading at 64.97$. The broad markets have started to recover some, but CVS has seemingly been left behind.
CVS is down -4.74% since I made the call
Due to the fact that we represented this trade thesis with options, we’re not down anything. In fact we’re up a little bit. We’ve collected 4.50$ in option premium already and are targeting another 0.75$ or so today for a total of about 5.25$. If we add our 5.25$ to the current price of 64.97 here’s our result:
[ (64.97 + 5.25) – 68.20 ] / 68.20 = +2.96%
Our CVS option trade is up 2.96%
That’s a 7.7% difference in return over just a two month period which is huge. If a trader was in the habit of even getting 1/4 of that benefit in the long-run it would add up to substantial outperformance.
So of course whenever I take an option trade I do a lot of careful consideration of all the moving parts and hopefully I’m right in my analysis. However if used correctly option trading does allow a pretty substantial margin for error because there are multiple factors at play and several ways to profit, not just price.
Buy and hold stock trading:
– Can profit only from price
– Can profit from price (delta)
– Can profit from time (theta)
– Can profit from volatility (vega)
Click here for a quick refresher course on the option Greeks. In this CVS trade we’ve been wrong on price thus far but our time decay theta gains have far offset that and we’re sitting on a nice profit. That’s only possible through option trading which is one of several reasons I think it has great value in portfolio management. Top 5 coming soon 🙂
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