AFOP options continued...

This is a continuation of post #403 of this board. Part of that post is pasted below.

Mar 18: AFOP ran up above $14. If you recall the AFOP positions were as follows:

3500 shares AFOP
5 short AFOP Mar14 $12.50 calls ($0.65 received)
5 short AFOP Mar14 $12.50 calls ($0.90 received)
5 short AFOP Mar14 $12.50 puts ($0.80 received)

Target allocation is 3% or 3000 shares. The range of 2.5-3.5% is ok and this range was set to take advantage of the stock’s volatility and undervaluation.

In the past couple of weeks, AFOP has run up from the $12-12.50 range to above $14. I believe the stock is still a good value but not as ridiculously undervalued as before.

With 3 trading days until the March options expire it appears as though the $12.50 puts will expire worthless. It also appears as though the $12.50 calls will be exercised and 1000 shares will be called away. If you recall, 500 shares were a trading position purchased at $12.20. These trading shares will, if called away will net 40 cents (Feb $12.50 calls which expired worthless) plus 65 cents (Mar $12.50 calls) plus 30 cents (difference between $12.20 purchase price and option strike price) for a gain of $1.35 per share or 11%.

Another 500 shares will be called away (also for $12.50 per share). This will drop the allocation to 2.5% or the low end of the desired allocation. The gain on these shares assuming an average purchase price of $12.20 will be 30 cents (gain on shares) plus 90 cents (premium for calls) plus 80 cents (premium for puts) for a total profit of $2 or 16.4%. The effective sale price (for tax purposes) is $13.40 because the premium of the calls is added. The real sale price considering that the puts were also sold adds another 80 cents: $14.20. For tax reporting purposes, though, the premium for the expired puts will be $0.80/share or $400.

Mar 18: Since I am now at the low end of the desired trading range, I decided to sell 5 more puts. I chose the $15 strike price because I believe that the stock has a good chance to run up further in the next month and I wanted more premium. I chose the April expiration because a) it offers the opportunity for me to sell more puts should the stock not move much, and b) it allows me to harvest the decaying time value of the options more quickly. So I sold 5 Mar14 $15 puts for a premium of $1.20. If the stock remains below $15, I will have the choice to a) let the shares get assigned at a price of $13.80 ($15 less the $1.20 premium received), or b) roll the options forward by repurchasing the April puts and selling the May puts. If b, then I would wait until very close to April expiration to maximize the difference in time value between the April and May options. Note 1: a purchase price of $13.80 may seem high considering that the shares were recently trading betweem $11.80 and $12.50; I am not worried about that. I just sold 500 shares for $14.20 (considering all the options premiums received) and I am still below my ideal 3% allocation for AFOP. Note 2: I am not selling any more calls at this time because I don’t want to lose more shares.

Reminder: The share amounts in these examples are not my actual share numbers and they are just for illustrative purposes.

The previous trades are below and can also be found in post #403.


Feb 2-6: Buy 3000 shares of AFOP at prices between $12.06 and $12.28. This is the 3% position.

Feb 11: Buy 500 shares at $12.20 trading position and sell 5 contracts of the Feb14 $12.50 call for $0.40 per share. I did not need to buy additional trading shares but decided to do so because of the potential upside and limited downside of the AFOP stock (that’s my personal opinion). I chose the Feb options because there was only one week left until expiration and there was a 40 cent per share premium. I considered this high because the stock was only at $12.20. This is a nice premium for only one week left. I chose the $12.50 strike price because it was close to the stock price at the time. In this situation (selling a covered call with not much time until expiration), you should get the most bang for your buck by selling strike prices close to the current stock price. The stock price closed below $12.50 at expiration on Feb 18th so I kept the premium and the trading position (500 shares). Had the stock closed above $12.50 on Feb 18th, my 500 shares would have been automatically sold from my account for $12.50 per share. I would also keep the 40 cents for the call so my proceeds including the options premium would have been $12.90 per share which would be a 5.7% gain in one week. Again, I was really indifferent as to whether the shares are taken away or not because as long as the price does not rocket up I intend to keep repeating my trading strategy monthly.

Feb 18: Sold 5 Mar14 $12.50 calls (note these calls expire on Mar 22, 2014 but I named them Mar14 where 14 is 2014) for $0.65 per share premium. These options expire on March 22nd. Last time I received $0.40 per share. This time I received $0.65. The premium is higher because there are 4 weeks until expiration (instead of 1 week). Also, the volatility may have changed and the underlying stock price may have moved. I don’t worry about the details of why it changed; I just look as the $0.65 being a good enough premium to open the trade. To summarize, I now own 3500 shares and I am short 5 contracts of the Mar14 $12.50 calls. This means that I own a 3.5% position and have the possibility to lose 500 shares if the price closes above $12.50 on March 22.

Feb 20: I decided to sell more options. The stock price was very close to $12.50 now so you can get a good bang for your buck. I sold 5 more Mar14 $12.50 calls and 5 Mar14 $12.50 puts. The premiums looked good: 90 cents for the calls and 80 cents for the puts. One trick to use is to enter the trade as a combination trade or a spread trade. When doing this, you are combining the 2 options into one trade so it will only execute if both are executed simultaneously. The advantage is that you can get a slightly better premium because options trade in 5 cent increments. However when you enter trades in combinations, the increments drop to 1 cent. Also, the bid ask spread on options can be high so entering combinations can give you a better deal. I received $1.73 per share on the sold calls and puts (when taken together). If I had enter the trades as 2 separate trades, I probably would have received only $1.70 instead of $1.73. Selling the puts and calls together has another big advantage: the closing price on March 22 cannot possibly be BOTH above and below $12.50. This means that one of the options must expire worthless (there is a rare exception which I’ll get into later). So to summarize, the total positions owned are the following: long 3500 AFOP, short 10 Mar14 $12.50 calls, and short 5 Mar14 $12.50 puts. The puts do add some risk that an additional 500 shares can be assigned on March 22 which would put the total AFOP position at 4000 shares or 4% of the portfolio. Yes, 4% is higher than the upper range of 2.5% - 3.5%. I am taking an additional risk here, but this risk can be mitigated in a number of ways. Recall that I received $1.73 per share on the equivalent of 500 worth of shares. This means that any assigned shares would need to drop below $10.77 ($12.50 assignment price less the $1.73 received for selling the March calls and puts). I think it is unlikely that the shares drop below $10.77 but I could sell 500 shares at any time should the stock drop. The other action I can take is to roll my puts forward just before options expiration. By rolling the puts forward, I would delay the assignment of the 500 shares on March 22 and collect additional premium in the meantime. Here’s how rolling forward works: buy back 5 contracts of Mar14 $12.50 puts and simultaneously sell 5 contracts of Apr14 $12.50 puts. This trade will give a net premium credit because the time value left on the April option will be greater than the time value left on the March option. To maximum the net credit, it is almost always best to wait until just before the expiration to initiate the trade. I think that is possible that I will do this in March and I’ll explain the details later, if I do.

1 Like

Chris -

Thanks for your continued discussion into your AFOP options strategy. I’ve followed it closely and enjoy your insight.

Thanks again.


Great post!

Really, this is is so valuable to a novice options guy like me.

Thanks so much,