One way to create a monthly cash flow is to purchase oil and gas securities and then sell stock options against these equities. These securities can be in the form of stocks or exchange-traded funds (ETFs). An ETF is a security that tracks an index or a basket of stocks like an index fund but trades like a stock. They provide the diversification of an index fund but can be bought and sold throughout the trading day. In this new investing section of Oilprice.com I will periodically highlight a stock or ETF and show how it can be utilized along with stock options to generate a monthly cash flow.
Today I am focusing in on UNG (United States Natural Gas Fund Lp). Let’s first look at a price chart of this ETF and notice how after a severe price decline and then a period of consolidation the trend has been bullish:
As of October 12, 2012 UNG was priced @ $23.16 per share. If we are bullish on natural gas we can purchase shares of UNG and then sell stock options to boost our income flow. A stock option gives the holder (not us, we are the sellers) the right, but not the obligation, to purchase our shares from us at a price we determine (the “strike price”), by a date we determine (the expiration date). In return for undertaking this obligation, we receive a cash premium that the market determines. Let’s say we purchase @ $23.16 and are willing to sell for $24 over the next one month. To determine how much we will get paid for undertaking this obligation we must access an options chain as shown below:
The quote of $0.67 is per share and each options contract consists of 100 shares. The November contracts expire on the 16th, about one month away. Let’s do some math (stay awake now!):
Buy 1000 shares @ $23.16 = $23,160.00 (our investment or cost basis)
Sell 10 contracts @ $67 = $670 = 2.9%, 1-month return
If share price goes to $24 or higher we gain an additional $0.84 per share = $840
Possible 1-month return = $670 + $840 = $1510
$1510/$23,160 = 6.5%, 1-month return
If the share price does not reach $24, the option will expire worthless as we keep our shares and premium and are free to sell another option the next month, generating a monthly cash flow. I will be showing different securities and different trading scenarios in future articles.
By. Alan Ellman