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What if shares of Apple (Nasdaq: AAPL) cost $10 instead of $100?
Even small investors could easily buy a few shares each month and build a sizable position over time – instead of being forced to buy Apple at $100.
Well, that’s exactly what happened in the options world. Back in late March of 2013 the Chicago Board of Trade (Nasdaq: CBOE) launched mini options in Apple, Amazon (Nasdaq: AMZN), Gold (NYSE: GLD), Google (Nasdaq: GOOG) and the S&P 500 ETF (NYSE: SPY).
Before then, you had to own 100 shares each of these high-priced companies or ETFs if you wanted to use a safe options strategy like selling covered calls or selling puts. (More on selling puts in a minute.)
So a 100-share lot of Apple would cost around $10,000 at today’s price, putting it well beyond the reach of most individual investors.
But a mini option allows you to buy 100 shares of the lower-priced stock. This essentially lets you use options on the equivalent of just 10 regular shares. For a stock like Apple, that means you only need a $1,000 investment in order to use covered calls.
And that means an investor who owns just 10 shares of Apple could use mini options to completely hedge a position or to generate extra income by writing a covered call or through selling puts.
How to Use Mini Options
Before the introduction of mini options, an investor with only 10 shares of Apple could not buy an out-of-the-money put to hedge a position or write a call option against shares without incurring unreasonable risk.
Let’s look at the example of an investor – let’s call her Caroline – who owns 30 shares of Apple.
As of just a few months ago, it was practically impossible for Caroline to earn income using covered calls. But today Caroline can write a mini call option against her 30 shares of Apple, and collect a minimum of $23 on the sale of a September 105 Apple mini call option.
At first, at least for most investors, this might not seem like a lot of income, but even $23 on 30 shares is 0.78% or an additional 5.5% in income annually.
Of course, she could also sell the 100 for $19 per contract or $57. That would equate to 2.5% or 17.5% annually.
If we again assume that Apple rises to $105 and the buyer of the mini call option exercises his right to buy 10 shares of Apple at $105, Caroline delivers her 10 shares and that is the end of it.
This is a low-risk way for Caroline – or any other savvy investor – to generate monthly income. If Caroline sold the September 105 Apple mini call option and Apple shares do not hit $105 before September 19th, the mini option expires worthless and Caroline pockets the $77 option premium she received. Caroline can then write another covered mini call option for October or November and do it all over again.
Sounds great right. So what’s the risk?
This is the worst case scenario: Let’s suppose Caroline originally bought her 10 shares of Apple at $70 and after selling a September 105 mini call option at $0.77 Apple shares subsequently tank. Caroline has reduced her cost basis for her Apple position by the $0.77 she received from the sale of the option. In many cases, investors will sell calls month after month, thereby reducing their cost basis substantially.
However, in this case, since Caroline only sold calls once she will not lose money until Apple falls below $69.33, which gives her a bigger cushion to ride out the ups and downs of being a long-term investor.
As you can see from the examples above, mini options give investors with smaller investment accounts the tools they need to generate additional income and reduce risk in some of the high-priced shares they own as odd lots.
To trade mini options, investors must open an options account with their broker. Investors should be sure they are authorized to write covered calls when they set up their options account so they can take advantage of this very conservative, income-generating strategy.
Mini options trade exactly the same way as standard options do. But, because they are new, they are available only for the five tickers listed above and they are less liquid than standard options, which are widely used by institutional investors to manage risk and to generate income.
But once individual investors realize how mini options can improve their investment performance, I think they will become much more popular and the demand for new mini option names will grow exponentially.
If you would like to learn more about how I use options for monthly income, don’t forget to take a look at my most recent webinar.