Yesterday, we talked about using covered calls with AVGO to generate cashflow over the past few months.
Covered calls are a great strategy to use — But they do have one big drawback, especially for a stock that was as expensive as AVGO was back in March.
See, back in March, AVGO hadn’t yet had its 10-for-1 split and was trading at more than $1200 per share.
With covered calls you need to buy the stock in chunks of 100 shares. So let’s do the math on that.
100 shares of AVGO x $1200 = $120,000 just to get started
While I love covered calls I’m not dense. I know that’s well out of reach for many traders just getting started.
So today I want to show you how we could have used the same exact stock (AVGO)… during the same exact timeframe (March 2024 to the present)… but with a more capital-efficient spread strategy.
Spreads
Don’t run for the hills. Whenever I mention spreads, some people get scared. They think it’s too complicated.
So let’s break it down: Spreads are just regular options that you trade in “pairs”.
Think of it this way: If I think AVGO is bullish, I might want to sell a put.
But if I don’t have margin on my account, I will need to have enough cash in my account to cover the purchase of those shares I’m selling the put on.
This makes selling a put somewhat similar to selling covered calls. The only difference is that with covered calls I need to spend the $100,000+ up front.
With naked puts, I just have to have it available in my account in case I get assigned the shares.
In both cases, I need to have over $100,000 available.
Spreads help me reduce the amount I need available.
Because in addition to selling a put, I’m also buying a put.
Let’s talk about it using specifics:
Round 1
Let’s look at AVGO on March 15. It was trading at about $1245 per share.
If I sell the 1150 put expiring April 19th and, in the same order, buy the 1140 put also expiring April 19th, I will get a net credit of $2.25.
That means I instantly collect $2.25 per share – or $225 for placing the trade.
It works exactly the same as selling an 1150 put, except that the 1140 put acts as my “backstop”.
Think of it this way: If AVGO falls below 1140 by expiration day, I will be forced to buy the stock at 1150 per share.
But because I’ve also bought an 1140 put, I can immediately force someone to buy it from me at 1140 per share.
That means I only lose $10 per share. Since I’m trading in chunks of 100, that means I can only lose $1000 maximum on this trade.
If you take into account the fact that I collected $225 up front for entering the trade, that means my max loss = $1000 – $225 = $775
That is the power of spreads! I no longer need $100,000+ to trade AVGO. I only need $1000!
Ok, now that you get the concept of spreads, let’s see how well AVGO would have worked out for us over the past few months.
We already know that we collected $225 on March 15th, while only risking $1000 if AVGO dropped below $1150 per share by April 19th.
And in fact, AVGO did drop! It dropped a few percent, closing at $1204 per share on April 19th.
But remember, we sold the 1150 put which means we came nowhere close to being in the money.
And as the options seller, that’s a great thing. It means we kept the full $225.
Let’s do some quick math to figure out how much we generated.
We risked $1000 and got $225 for it. That means we generated $225 on $775 of risk.
If we divide 225 / 775, that gives us 0.2903 or 29.03% return in 30 days. That’s pretty outrageous!
Round 2
Fresh off our awesome win, on Monday, April 22nd, we turn around and sell another put spread.
With AVGO trading at 1214, we sell the 1130 put and buy the 1120 put, both expiring on May 24 for $2.70.
That means we instantly collect $270. And remember, because the difference between the strike prices is $10, we multiply that by 100 to see that we’re risking $1000.
Same math as before $1000 – the $270 we collected = $730
270 / 730 = .3698 or 36.98% return… For just 5 weeks in the trade.
How did it do? By expiration, AVGO was up above 1400 per share, giving us an easy win.
We kept the full $270 we collected and wait till the following week to place another trade.
Round 3
Monday, May 27th was Memorial Day in the U.S., so markets were closed.
On Tuesday the 28th, AVGO was trading around 1405.
We decide to sell the 1305 put and buy the 1300 put, both expiring on June 28.
We “only” collect $1.60 per option for a total of $160.
Why are we collecting less? Remember, our previous trades we collected over $200.
Look at the strike prices. They are only $5 apart. That means we’re only risking $500 per contract!
Let’s do the same math as before: $500 difference in strikes – $160 collected = $340 risk
and 160 / 340 = 0.4705 or 47.05% return!
Even though we’re collecting less cash, our risk is dramatically less than the previous trades.
And don’t worry — if you still want to risk $1000, you can just trade 2 contracts instead of 1!
How did that trade work out? During that month that the trade was open, AVGO dipped a little bit.
But then it took off like a rocket, closing on expiration day at over 1600.
That means we kept the full $160 we collected and moved on with our lives.
Round 4
On Monday, July 1 with AVGO trading around 1605, we could have sold the 1490 put and bought the 1485 put, both expiring August 2 for a net credit of $1.45.
Again, look at the strikes. They’re $5 apart, so that $145 we collect on the $355 we risk is 40.85% return.
The trade is still open — and to make things more interesting, AVGO has had a 10-for-1 split since this hypothetical trade opened.
So our 1490 put is now a 149 put.
With AVGO currently trading at $160.52, it’s more than 7% above our strike price, so we still have a nice cushion.
I’m not going to lie— this week all of tech has been having some trouble.
So this could actually close in the money. But remember, we’ve already hypothetically collected $800 for the 4 trades we’ve placed.
And our risk on the open trade is only $355.
Let’s say AVGO does close below the strike we sold. We’d still be in great shape.
Summary
That’s the power of spreads. They let you collect instant cash, just like with covered calls.
But unlike covered calls, you don’t need to have a mountain of cash to buy the stock beforehand.
Of course, now that AVGO has had its 10-for-1 stock split, it’s a whole lot more affordable, so covered calls might actually be viable for you.
It’s all about what your comfort level is.
And remember, I always recommend that you paper trade these strategies before you get started with real cash.
That lets you work out the kinks and learn the ins and outs of your trading platform before you risk real cash.
UPDATE: If you’re curious about using monthly vs weekly spreads, I answer that question here.
Trade well,
Jack Carter
P.S. I spotted a $3.5 million flood of Wall Street cash going into NVDA… And THIS is how I’m going to play it.
