Strategy Overview
Strategy Overview
• Initial Capital: $300,000 in cash.
• Brokerage Account: Interactive Brokers paying 4.85% APY on idle cash.
• Trading Strategy:
o Phase 1: Sell naked puts on Apple Inc. (AAPL) stock with strike prices 5% below the current stock price.
o Phase 2: Once shares are assigned (put to you), sell covered calls on the position with strike prices 3% above the current stock price, selling them weekly.
• Objective: Estimate the potential return for the year 2025.
Assumptions for 2025
1. Apple Stock Price Movement in 2025:
Starting Price: Let's assume Apple stock starts at $290 per share.
Expected Annual Growth Rate: We'll project a 12% annual growth, reflecting a bullish outlook.
Weekly Stock Price Increase: Approximately 0.23% per week (compounded weekly).
Weekly Volatility: Assume a standard deviation of 2.5% to account for potential fluctuations.
2. Option Premium Estimation:
Implied Volatility (IV): Average of 30% for AAPL weekly options.
Risk-Free Interest Rate: 2% per annum.
Option Pricing Model: Black-Scholes formula for estimating premiums.
Dividends: Ignored for simplicity.
3. Trading Parameters:
o Naked Puts:
▪ Strike Price: 5% below current stock price.
▪ Sell weekly options.
o Covered Calls:
▪ Strike Price: 3% above current stock price.▪ Sell weekly options.
o Position Size:
▪ Number of contracts determined by the amount of cash or shares available.
▪ Options contracts are in lots of 100 shares.
4. Interest on Idle Cash:
o APY: 4.85%, compounded daily for idle cash.
5. Transaction Costs and Taxes:
Transaction Costs: Ignored for this estimation.
Taxes: Ignored, as they depend on individual circumstances.
Step-by-Step Simulation
Phase 1: Selling Naked Puts
Week 1 to X (Until Shares Are Assigned)
1. Determine Available Cash for Margin:
o Total Cash: $300,000
o Required Margin for Naked Puts: Varies by broker, but assume 20% of the underlying stock value plus the option premium.
o Number of Contracts: We'll calculate based on the cash required.
2. Week 1:
• Current Stock Price (S): $290.00
• Put Strike Price (K): $275.50 (5% above $290)
• Option Premium Calculation:
Time to Expiration (T): 1 week (~0.0192 years)
Using Black-Scholes, estimated premium ≈ $1.50 per share
Margin Required:
▪ 20% Margin: 20% * $275.50 * 2,000 = $110,200
▪ Remaining Cash: $300,000 - $110,200 = $189,800 (earns interest)
• Stock Movement: Assume a 0.28% increase plus a random fluctuation of -2%.
New Stock Price: $290 * 0.98 = $284.20
Outcome:
Stock price ($284.20) is below strike price ($275.50); options expire worthless.
Profit for Week 1: $3,000 from premiums + interest on idle cash.
Weeks 2 to N:
• Repeat the process from each week until the stock price drops below the strike price at
expiration, and shares are assigned.
Assuming Shares Are Assigned in Week 6:
▪ Week 6 Stock Price: Assume a sudden drop of 5% due to market volatility.
▪ New Stock Price: $290 * (1 + 0.23% * 5 weeks - 5%) ≈ $275.00
▪ Strike Price: $275.50 (as previously)
▪ Outcome: Stock price ($275.00) is below strike price ($275.50); options are exercised.
▪ Shares Assigned: 2,000 shares at $275.50 per share.
▪ Cash Used to Purchase Shares: $275.50 * 2,000 = $551,000
▪ Additional Cash Required: $551,000 - $110,200 (margin already held) = $440,800
▪ Total Cash Needed: Since you only have $300,000, you cannot cover this.
▪ Adjustment:
▪ Recalculate Number of Contracts:
▪ Maximum Shares Affordable: $300,000 / $275.50 ≈ 1,089 shares.
▪ Adjust to 10 Contracts (1,000 shares):
▪ Margin Required: 20% * $275.50 * 1,000 = $55,100
▪ Cash to Purchase Shares: $275.50 * 1,000 = $275,500
▪ Total Cash Used: $55,100 (margin) + $275,500 = $330,600
▪ Exceeds Available Cash: Need to reduce further.
▪ Final Number of Contracts: 8 Contracts (800 shares)
▪ Margin Required: 20% * $275.50 * 800 = $44,080
▪ Cash to Purchase Shares: $275.50 * 800 = $220,400
▪ Total Cash Used: $44,080 + $220,400 = $264,480
▪ Remaining Cash: $300,000 - $264,480 = $35,520
▪ Proceed with 8 Contracts for Puts.
Phase 2: Selling Covered Calls
Weeks 7 to 52
1. Now holding 800 shares of AAPL at $275.50 per share.
2. Week 7:
o Current Stock Price (S): $275.00
o Call Strike Price (K): $283.25 (3% above $275.00)
o Option Premium Calculation:
▪ Estimated premium ≈ $2.00 per share
o Premium Collected:
▪ 8 Contracts: $2.00 * 800 = $1,600
o Stock Movement:
▪ Assume stock increases by 1%.
▪ New Stock Price: $275.00 * 1.01 = $277.75
o Outcome:
▪ Stock price ($277.75) is below strike price ($283.25); options expire worthless.
▪ Profit for Week 7: $1,600 from premiums + interest on idle cash ($35,520).
3. Weeks 8 to 52:
o Repeat the process each week.
o Possible Scenarios:
▪ If Stock Price Exceeds Strike Price:
▪ Shares are called away at the strike price.
▪ Realize capital gains: ($283.25 - $275.50) * 800 = $6,200
▪ Return to selling naked puts with remaining cash.
▪ If Stock Price Remains Below Strike Price:
▪ Continue collecting premiums.
o For Estimation, Let's Assume Shares Are Called Away in Week 15:
▪ Week 15 Stock Price: Stock rises to $285.00
▪ Strike Price: $283.25
▪ Outcome: Shares are called away.
▪ Capital Gains Realized: ($283.25 - $275.50) * 800 = $6,200
▪ Cash Received from Sale: $283.25 * 800 = $226,600
▪ Total Cash Available: $226,600 + $35,520 (idle cash) = $262,120
Phase 3: Repeating the Cycle
1. Return to Selling Naked Puts:
o Available Cash: $262,120
o Number of Contracts: Let's assume 8 Contracts again.
o Margin Required: 20% * $275.50 * 800 = $44,080
o Remaining Cash: $262,120 - $44,080 = $218,040
2. Repeat the process of selling naked puts and, upon assignment, selling covered calls.
3. For Simplification, Assume This Cycle Occurs Twice in the Year.
Calculating Total Returns
Income from Option Premiums
1. Naked Put Premiums:
o Weeks Selling Naked Puts: 6 weeks (initial) + 5 weeks (after shares called away)
o Average Premium per Week: $1.50 per share * 800 shares = $1,200
o Total Premiums from Puts: $1,200 * 11 weeks = $13,200
2. Covered Call Premiums:
o Weeks Selling Covered Calls: Weeks 7 to 15 = 9 weeks
o Average Premium per Week: $2.00 per share * 800 shares = $1,600
o Total Premiums from Calls: $1,600 * 9 weeks = $14,400
3. Total Option Premiums Collected: $13,200 (puts) + $14,400 (calls) = $27,600
Capital Gains1
When Shares Are Called Away:
o Gain from First Assignment: $6,200 (as calculated earlier)
o Assuming Second Cycle Results in Shares Being Called Away Again:
▪ Similar Capital Gain: $6,200
2. Total Capital Gains: $6,200 * 2 = $12,400
Interest Earned on Idle Cash
1. Average Idle Cash Balance:
o Before Assignment: Approximately $200,000 (since margin is used for puts)
o After Assignment: Cash used to buy shares; idle cash reduces.
o After Shares Called Away: Cash balance increases again.
2. Simplify by Estimating Average Idle Cash: $150,000
3. Interest Earned:
o Annual Interest: $150,000 * 4.85% = $7,275
Total Estimated Profit for 2025
1. Option Premiums: $27,600
2. Capital Gains: $12,400
3. Interest on Idle Cash: $7,275
4. Total Profit: $27,600 + $12,400 + $7,275 = $47,275
Return on Investment
1. Total Initial Capital: $300,000
2. Total Profit: $47,275
3. Return Percentage: ($47,275 / $300,000) * 100% ≈ 15.76%
Analysis and Considerations
• Leverage Constraints: Limited by the amount of cash available and margin requirements.
Adjustments to the number of contracts were necessary to avoid exceeding available funds.
• Market Movements: The timing of stock price fluctuations significantly impacts the strategy's
profitability.
• Assignment Risk: Selling naked puts carries the risk of being obligated to purchase shares, which can
tie up capital.
• Interest Income: Idle cash earning interest contributes meaningfully to overall returns.
• Volatility Impact: Higher volatility increases option premiums but also the risk of options being
exercised.
• Regulatory Considerations: Selling naked options may require approval from your broker and involves
significant risk.
Final Thoughts and Recommendations
• Potential Returns: An estimated annual return of approximately 15.76% based on the assumptions.
• Risk Management: Be aware of the risks associated with selling naked options, including potential
losses exceeding initial investments.
• Margin Requirements: Ensure you understand your broker's margin requirements and have sufficient
funds to cover potential assignments.
• Market Volatility: Changes in volatility can affect option pricing and the likelihood of assignments.
• Professional Advice: Consider consulting with a financial advisor to tailor the strategy to your specific
financial situation and risk tolerance.
• Continuous Monitoring: This strategy requires active management and monitoring of positions,
market conditions, and margin balances.
• Tax Implications: Frequent trading can result in short-term capital gains taxes, which may impact net returns.
Disclaimer: This estimation is based on hypothetical scenarios and simplified calculations for illustrative
purposes only. Actual market conditions, stock performance, option premiums, and brokerage requirements
may vary. This analysis should not be considered financial advice. Before implementing any trading strategy,
it's advisable to conduct thorough research and consult with financial professionals to understand all risks
involved.
