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Would you like to own 10 shares of Apple (NASDAQ: AAPL) for a 15.8% discount?
Back in March 2013, the Chicago Board of Trade launched mini options in Apple, Amazon (NASDAQ: AMZN), SPDR Gold Shares (NYSEArca: GLD) and Google (NASDAQ: GOOGL).
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.)
A 100-share lot of Apple would cost over $10,000, but a mini option allows you to buy just 10 shares of the stock if you sell puts on the stock for a fraction of the cost.
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 Sarah – who wants to buy 30 shares of Apple. She plans on selling puts to lower her cost basis of the stock that she eventually hopes to own.
There was a time when it was practically impossible for Sarah to sell puts on Apple without potentially having to buy 100 shares of the stock, an amount of capital she just couldn’t afford. But today Sarah can sell puts on the tech behemoth and acquire shares at a much lower cost.
At today’s prices she can sell three puts at the January 100 strike and collect $2.75 per contract, or $27.50. However, she wants to sell three contracts, so that would equate to $82.50 on the sale of three January 100 Apple mini call options that are due to expire in roughly three months.
At first – at least for most investors – this might not seem like a lot of income, but even $82.50 per quarter on 30 shares is $330, or 2.8% a quarter (11.2% annually). And remember, that’s without buying a single share.
Sarah prefers to apply the premium collected through selling puts to lower her cost basis, rather than use the put premium as income. In this case, Sarah would apply the $2.75 per put contract sold to lower the cost basis to $97.25. That is a 15.8% discount from Apple’s recent price of $115.50.
A Repeatable Process
Selling three puts at the January 100 strike requires us to have $3,000 of cash in our trading account.
If Apple closes at January expiration above $100, we keep the $82.50 and simply repeat the process by selling more puts, maybe at the $100 or possibly at a different strike price. Our chosen strike depends on where the stock is trading at the time we wish to sell more puts and how much premium we wish to bring in.
If the stock trades for less than $100 at January expiration, we are assigned the stock at $100, 10 shares per put contract sold. Oftentimes when this occurs I will begin to sell covered calls on the stock so there is an ongoing source of income coming in. I take this approach in one of my High Yield Trader portfolios, appropriately named “The Income Cycle.” If you would to learn more, click here.
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 sell puts and 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. But because they are new, they are available only for the few tickers listed above and they are less liquid than standard options, which are widely used by institutional investors to manage risk and 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.