Case Study: JAN25
Background: The Smiths are exploring diversification strategies for their portfolio after reading an iInvest blog. They like following the market and are particularly interested in the structured nature of options to achieve their goals. Below is a summary of their current portfolio and goals:
- Current Holdings: 100% exposure in 5,000 NAB shares, valued at $195,000 ($39 per share).
- Investment Goals:
- Not in a rush to sell NAB shares but willing to sell if the stock price reaches ~$40.00.
- An additional $100,000 available for investment.
- Preference for diversifying into one resource stock. Will diversify further if the NAB is sold.
- Cautious about miners at current levels but open to investing if prices decline.
Proposed Strategy: To align with the Smiths’ goals, we recommended a strategy incorporating two simple options strategies: covered calls and cash-covered puts.
- Covered Calls:
- The Smiths can sell covered call options against their NAB ($39.00) equity holding. This approach enables them to set a desired sale price of $40.00 while earning additional income.
- Details of the trade:
- Sell 50 call option contracts with a $40.00 strike price, expiring in 1 month.
- Premium received: $0.50 per share, generating $2,500 in income.
- Potential Outcomes:
- If NAB stock remains below $40.00 at expiry, the Smiths retain their shares and can repeat the strategy for another month, earning another ~$0.50 per share (adding up to $5,000 for the strategy).
- If NAB stock trades above $40.00 at expiry, they will be obligated to sell their shares at $40.00. If this is in month 1, the effective sale price is $40.50, in month 2 it would be $41.00.
- Cash-Covered Puts:
- The Smiths can sell cash-covered put options in FMG ($19.25), providing an opportunity to acquire FMG shares at a lower price while earning income in the interim.
- Details of the trade:
- Sell 50 put option contracts with an $18.50 strike price, expiring in 1 month. ($92.5k exposure)
- Premium received: $0.40 per share, generating $2,000 in income.
- Potential Outcomes:
- If FMG trades above $18.50 at expiry, the puts will expire worthless, and the Smiths keep the $2,000 premium.
- If FMG trades below $18.50 at expiry, the Smiths will be obligated to purchase the shares at $18.50. Factoring in the $0.40 premium, their effective purchase price will be $18.10 per share.
Margin & Settlement:
- To facilitate these trades, the Smiths have lodged their NAB stock holding as collateral. This collateral covers the approximate ~$40,000 margin obligation required to open both positions.
- The income from selling options (+$4,500) will be credited to their cash management account the following day.
Summary of Benefits:
- Income Generation: The combined premiums from the covered calls and cash-covered puts provide an immediate income of $4,500 for the first month.
- Controlled Sale Price: The covered call strategy sets a predefined sale price for NAB shares while enhancing returns.
- Opportunity to Diversify: The cash-covered put strategy allows the Smiths to potentially acquire FMG shares at a lower price, aligning with their cautious view on miners.
- No leverage: Getting the contract sizing correct means the Smiths positions are not leveraged, a key consideration when utilising these strategies.
This approach offers a structured, income-generating pathway for diversification while respecting the Smiths’ investment preferences.
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