How to use options to collect rent on stocks without owning them

When trading stock options, one of the disadvantages of writing covered calls is the heavy upfront capital costs required to actually own the underlying stock before you can write/short the call. After all, this is the hedged part of the covered call strategy, which applies to any stock in any stock sector.

Selling a bare call doesn’t require you to own the shares, but it comes with risks that could cost you significantly more money if you lose. These can be much riskier than selling a naked put since a stock can only go to zero on a downturn. If a short squeeze causes the stock to shoot higher than the strike price, you are on the verge of having to buy it on the open market to then be assigned to the lower strike price.

For example, if you write a bare call on XYZ at $55 and $55, resulted in a loss of $4.

Collect rent to own shares

We compared writing covered calls to collecting rent on the stocks you own. Here’s a way to collect the same rent without actually owning the shares. It’s like being a landlord and collecting rent without actually owning the property.

Putting the pieces together

There is a strategy that allows you to enjoy income from covered calls without actually committing capital to own the underlying stocks. If you’ve already read our articles on covered call options, debt spreads, Greek options, and LEAPS (long-term equity appreciation stocks) options, then you have the foundation to put the pieces together long call diagonal debit spread (LCDDS), which literally allows you to collect rent on shares you don’t own.

Long Call Diagonal Debit Spread (LCDDS)

The LCDDS strategy seems complicated, but it is a pretty simple two-legged options strategy once you understand the mechanics. Simply put, you will purchase an in-the-money (ITM) LEAP call option while selling or shorting a short-term out-of-the-money (OTM) call option on the same underlying stock you are bullish on. . This bullish part is important, so be sure to use larger timeframe charts to perform technical analysis.

By selling the short-term OTM call, you collect a premium, which the ITM LEAP call option takes on as a substitute for the underlying stock in the event it is assigned to you. The LEAP call option typically costs 70% less than buying a stock. Once again, the LCDDS strategy can be summed up in one sentence:

Buy an ITM or DTM LEAP call option and sell a short-term OTM call option on the same stock.

Put on the market

Let’s take a real life example with Southwest Airlines Co. NYSE:LUV. The company reported a solid fourth-quarter 2023 earnings report, more than tripling its EPS to 37 cents versus analysts’ consensus estimates of 12 cents. Revenue rose 10.5% year over year to a record $6.82 billion, beating analysts’ estimates of $6.75 billion.

The weekly candlestick chart indicated a breakout of the ascending triangle through the market structure low (MSL) trigger of $30.07. The weekly relative strength index (RSI) is steadily rising towards the 60 band. There is a triangle support at $27.25 and further pullback support levels at $25.78 and $24.92. LUV trades at around $31.18 on February 7, 2024.

Based on this data, we perform the first part of the operation, taking long a LUV $25 LEAP calls for $8.68, expiring on January 17, 2025, i.e. in 345 days. Since options contracts represent 100 shares a piece, 1 contract will cost $868, which is much cheaper than buying 100 LUV shares for $3,118. Note the Greek options. The Delta of 0.8180 reflects how much the option price changes per $1.00 price movement in LUV. The Theta of $0.0066 reflects the amount of money the option loses on a daily basis.

To collect our rent premium, let’s go sell/short a $33 LUV call option for 47 cents, expiring on March 8, 2024, i.e. 30 days from today. This is the premium we can keep regardless of where LUV closes in a month. The $47 represents a 5.4% monthly gain on your $868 investment (the price of the LEAP call option). If we bought 100 LUV shares, it would equate to a gain of only 1.5% on the $3,118 invested in the shares. This is the second stage and completes the execution of the LCDDS position. However, it is important to manage the trade.

Calculate the price of future options using Greeks.

Here’s a quick way to use Options Greeks to estimate the value of an options contract at expiration. If the LUV closes at $34.18 at expiration on March 8, 2024, we have derived a value for the LUV $25 LEAP on January 17, 2025 of $11.05.

We will use the Delta, Theta and Gamma values ​​from the LEAP option in the screenshot. We use Greek options to calculate the premiums of a net gain of $3.00 expiring in 28 days. Delta premium is 0.8180 x $3.00 price increase for a $2.45 premium. Theta is -0.0066 x 28 days for -18 cents. The range of 0.0230 x 0.5 is 10 cents. The total option price gain is $2.45 Delta + 10 cents Gamma minus 18 cents Theta = $2.37 net gain + $8.68 initial call cost LEAP = $11.05 estimated value of the call option $25 LEAP.

Results are due.

Let’s examine the outcome under different scenarios based on the LUV share price at the March 8, 2024 expiration.

If LUV closes below the $33 strike price of the short call, we maintain the $47 premium for a monthly profit of 5.4%. We can sell/re-house a LUV call or roll it over to the $33 April call to reap more rewards.

Compare this result to the 1.5% monthly gain if we executed a traditional covered call strategy by buying $3,118 shares and writing the March $33 covered call for 47 cents.

If LUV closes ITM at $34.18, the $25 LEAP call option would be worth about $11.05. We have explained how to calculate the future value of options using the Greeks above.

The $33 short call position would result in a loss of $1.18. If we calculate the $11.05 value of the LEAP call and add the 47 cent premium for a total of $11.52, then we can calculate the costs of $8.68 for the LEAP call and the loss of $1.18 on the short call position for a total of $9.86. We subtract the premiums of $11.47 minus the costs of $9.86 for a final net gain of $1.66 in profit or $166, which is a Monthly earnings of 19.1%..

Compare this to the Monthly earnings of 7.3%. for a traditional covered call strategy that would result in a profit of $182 if assigned to the strike price of $33 from our entry price of $31.18 and premium of $47 for a total profit of $229.

More earnings at lower costs

The LCDDS strategy in this example provides a monthly premium of 5.4% and a monthly gain of 19.1% if LUV closes above $33, at $34.18 at March expiration. This compares to the 1.5% monthly premium and $7.3% monthly gain with the traditional covered call strategy, which costs 70% more capital to execute. We will cover more multi-law options strategies in future articles.

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