Covered Call Option Trade Review on Ford Motor Co

Lately, I’ve been experimenting with an option trade I call the “steak dinner trade.” I own 1,000 shares of Ford (F) stock because I believe they have a better chance of building and selling electric vehicles (EVs) than Tesla (TSLA) does. So far, my hypothesis hasn’t paid off in share appreciation, but rather in weekly income that can pay for a steak dinner for two.

The majority of people go long on options (to buy) and they pay a premium for the right to buy a stock at a predetermined price, also known as the strike price. Money flows from your account to the trader that offers the option. In the case of the option buyer, the time (theta) decay works against them, but theta decay works the opposite way for the option seller. Theta decay works for the seller.

I’m very risk-conscious, and selling a call option to someone is risky because my upside risk isn’t capped. The way around this risk is to put up any shares of the underlying asset as collateral. This is called selling a covered call. You sell the call option to someone, collect the premium, and put up the underlying asset you own as collateral.

That’s what I’ve been doing with Ford. I sell 10 weekly call option contracts at a higher strike price than what Ford is trading at, collect the premium, and use my 1,000 shares of Ford stock as collateral.

Sample Ford (F) Covered Call Trade (aka Steak Dinner Trade) On July 19, 2024, I sold 5 covered calls on Ford (F). The strike price was $14.50 and the options would expire one week later, on July 26, 2024. Ford was trading around $14 a share. I collected $0.26 of premium per share, so that’s $0.26 * 5 * 100 = $130 of premium.

The day before expiration, I closed out the trade at $0.01, so my net premium was $0.25 (less fees), resulting in roughly $124.51 collected. That's a Rate of Return (ROR) of 104%!

That return and premium pay for a nice steak dinner for two at a good dining establishment.

Why I Close My Covered Calls

I rarely let them expire; I prefer to buy back my covered call the day before expiration when the premium is roughly 10% of what I sold it for. I do this to safeguard my actual shares of Ford because if the option isn’t exercised before expiration, I get to keep the premium I collected and my shares.

Neat, right? Well, there’s always a snag. What if the Ford stock price is higher than the strike price I sold at? What if my covered call option gets exercised? What then? There’s a high likelihood that some or all of my Ford stock will be sold off and moved out of my account.

I would end up collecting the premium and getting any capital gains or losses from selling my Ford stock.

For a sleepy blue-chip company like Ford, that’s a risk I’m willing to take, and the data supports my decision.

Option Exercise Risk

Data supposedly parroted from the CBOE and OCC (I can never find the reference) states that only 10% of options are ever exercised. That doesn’t mean they don’t expire In-The-Money (ITM), but more often they expire Out-of-The-Money (OTM).

On the surface, that sounds like a good deal; 90% of the time your covered calls won’t be exercised, but there’s more probability on your side.

Half of the time, roughly 55 to 60%, the option contracts get closed out, just like what I do weekly. They don’t expire worthless; the contract just gets closed before expiration.

The remaining 30% or so of options do expire worthless.

The net result of all this is that the odds are indeed in my favor as a seller of premium, but never 100%. Market conditions change so fast, and you could lose big time if you’re naked.

What do I mean by naked? It’s when you have no collateral (aka covered calls) or cash (cash secured put). That’s where you end up blowing up if you don’t use protective option selling strategies - that’s for another post altogether.

TL;dr

Selling covered calls on Ford Motor Co. has been a profitable strategy for me, allowing me to generate a steady stream of income despite the stock's lackluster performance in terms of share appreciation. By carefully selecting strike prices and expiration dates, I’ve been able to mitigate risks while enjoying the benefits of premium collection. My "steak dinner trade" is a testament to the potential of covered call strategies, especially for investors who own substantial shares of stable, blue-chip companies.

However, it's crucial to remain vigilant and manage risks effectively. The potential for options to be exercised means that having a solid exit strategy is essential. Understanding market conditions and staying informed about your investments can help you make more informed decisions and protect your assets.

In the world of options trading, nothing is ever guaranteed, but with careful planning and a disciplined approach, selling covered calls can be a valuable tool in your trading arsenal. Whether you're looking to generate extra income or simply protect your investments, the key lies in understanding the mechanics and risks involved, and always being prepared for any market scenario.

Happy trading, and may your steak dinners be frequent and well-earned!

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