Last week, we sold some put options on RIO which is a stock in the Materials sector. As our objective is to build a diversified portfolio, this week we will sell put options on a stock from a different sector. Although the Australian market is holding up well, global markets have been quite bearish in the past couple of weeks. Volatility in the market is rising again so it is time to get defensive. As you can see in the table below, stocks in defensive sectors (shaded in green) are usually the least volatile.
Trade Transactions This Week
Wesfarmers: WES June $29.50 PUT
As usual I start by using Vector Vest, my stock analysis tool to help me to find ASX200 stocks from the defensive sectors which have options. I sorted the list by the “Relative Safety” indicator and not surprisingly, stocks from the Consumer Staples appeared at the top of the list. I liked Wesfarmers best because there was strong support (green line) close to its current price as shown in the chart below.
As WES is a stock that pays good dividends, I am happy to own the shares. To increase my chances of getting my put options exercised, I will sell ATM put options. I would also like my options to expire before they go ex-dividend in August.
As you can also see from the options chain above, I can sell a June $29.50 put option for $0.59 per share. If my put options get exercised in June, I will get to buy WES shares at $28.91 ($29.50 strike price – $0.59 premium received). Based on WES’s dividend history, it is very likely that WES would also declare a final dividend of $0.85 cents in August which will include another $0.36 of franking credits as WES dividends are fully franked. This will further reduce my cost (and hence risk) of owning WES shares to $27.70 ($28.91 – $0.85 dividend – $0.36 franking credit).
As our allocation for each stock position is $30,000, we can sell 10 contracts of WES June $29.50 puts. This means that I am making a commitment to buy 1000 (10 contracts x 100 shares per contract) shares of WES at $29.50 per share, and I need to set aside $29,500 of my cash to purchase the shares in case my put options get exercised in June. A portion of this cash will be required to cover margins but most of the cash will continue to earn interest in my Cash Investment account for the next two months while waiting for the puts to expire. I will receive $590 ($0.59 x 1000 shares) for making this commitment.
My primary exit for this trade is for my put options to get exercised so I will get to buy WES shares at $28.91 ($29.50 strike price – $0.59 premium received) which is a $0.73 discount to today’s price of $29.64. This would be the case if WES stays below $29.50 when the put options expire on June 28.
My secondary exit for this trade is for my put options to expire worthless. This would be the case if the WES share price is above $29.50 when the options expire in June. This means I simply get to keep the $590 of premium income which is a 2% return in just over two months or an annualised return of 11.23%.
Model Portfolio Update
National Australian Bank: NAB May 24.50 PUT
On April 11, I sold to open NAB May $24.50 put options for $0.62 when NAB was trading at $24.42. Since then NAB shares have gone up in price. Today NAB is trading at $25.09 and my put options are now only worth $0.21.
For more information about this trade set up, read my April 11 model portfolio update.
Rio Tinto: RIO July $64.00 PUT
On April 18, I sold to open RIO July $64.00 put options for $2.04 when RIO was trading at $66.08. Since then RIO shares have gone down in price. Today RIO is trading at $65.95 and my put options are now worth $2.03.
For more information about this trade set up, read my April 18 model portfolio update.
Current Open Position Snapshot
I will be providing a weekly update on this model portfolio on this blog. If you are intrigued by our income strategy but have trouble following the discussions in this post, you will need to first download and read our e-book in order to understand the strategy and do some basic options education (found on our Resources page) to familiarise yourself with option terminology.
Disclaimer: This post is for educational purpose only and should not be treated as investment advice. This strategy would not be suitable for stock investors who are not familiar with exchange traded options. Any readers interested in this strategy should do their own research and seek investment advice if required.