Thur Apr 9, 2009: High Short-Term Income from Selling Option Combinations

Option investors who want to take advantage of high premiums currently available due to recent volatility in banking stocks might consider writing a combination of puts and calls on Bank of America stock (NYSE-BAC, $9.55).

For example, the BAC April 9.00-10.00 option strangle provides a one-week income of 18.4% ignoring commissions, and additional income could be generated the Monday following expiration once the new underlying stock position (if any) is known.

This assumes a margin requirement of 50% of the higher strike price, or $500 per strangle of 100 shares per position, with an income of $92 per combination of one put and one call.

The expectation is not necessarily that both sides of the combination will expire worthless, but that the high percentage income will make the risk worthwhile, and a flexible patient option writer can accept assignment on one side then sell covered options for the next month.

If BAC stock finishes below $9 per share next Friday the stock would be put to the option writer, who could then write covered calls to generate additional income.

On the other hand, if BAC stock finishes above $10 per share next Friday the stock would be called from the option writer, creating a short position, against which covered puts could then be written.

The initial profitability range for this trade is between $8.08 and $10.92 per share at expiration next Friday.

The upside risk is theoretically unlimited, as BAC stock could continue higher and the $10 call is naked.

The downside risk is a loss of $808 per strangle combination if BAC goes to zero.

The most likely outcome is assignment on one side or the other, although it is possible the stock finishes between 9 and 10 and the trade is over at that point. In any case, the $92 per combination is income in your pocket.

Until next time, best of luck with your option investments!