Can Options Be Better Than a Margin Loan?

Investors often seek alternative methods to finance their investments and manage their portfolios effectively. Two prominent options include utilizing a margin loan or using options strategies like covered calls and poor man's covered calls. This article will explore these strategies in the context of an NVDA investment, providing insights into how options can potentially offer better financial outcomes.

Understanding the Scenario

Let's consider a real scenario where an investor holds 500 shares of NVDA, priced at $134 per share. The total investment amounts to$52,746.92, with $14,253.08 financed through a margin loan at a 9.24% interest rate per 360 calendar days. The objective is to hold NVDA for a long-term period of five years or more. The investor is contemplating using options like covered calls and poor man's covered calls to offset the expenses of the margin loan.

Exploring Options Strategies

Covered Calls

Covered calls are an income-generating strategy involving selling call options on shares you already own. For NVDA, selling far out-of-the-money (OTM) calls can generate premiums that offset some of the margin interest. The key is to select strike prices above your long-term target to minimize assignment risk, allowing you to retain your shares. Monthly expirations strike a balance between premium decay and time exposure.

Example Calculation

Assume you sell OTM covered calls at a $150 strike price, with a premium of$2 per option. This provides an income of $1,000 (500 shares / 100 shares per contract *$2) per month. Over a year, this translates to $12,000, significantly reducing the margin loan cost.

Poor Man's Covered Calls

This strategy mimics covered calls with less capital by purchasing a deep in-the-money (ITM) Long-term Equity Anticipation Security (LEAPS) call and selling shorter-term OTM calls against it. LEAPS are options with expirations extending up to 2-3 years from the current date.

Buying LEAPS that expire in 1-2 years provides flexibility. You can sell monthly OTM calls for regular premium income. This setup can be a more cost-effective alternative to continuously rolling weekly options.

Considerations for Managing Costs

When employing options, it's crucial to select strike prices and expiration dates carefully, keeping in mind how option premiums can cover loan interest. This means weighing the net premiums received against the margin loan's interest costs.

Benefit of Using LEAPS

LEAPS can be more cost-effective than rolling weekly options. Their longer duration often results in lower implied volatility risk and transaction costs, allowing for better management of long-term holdings.

Final Thoughts

Options strategies like covered calls and poor man's covered calls can provide viable paths to offsetting the costs associated with a margin loan. However, ongoing vigilance is required to ensure options do not adversely impact long-term holdings due to potential assignments or significant price movements. Using a trading journal or data analysis platform such as WealthBee can be instrumental in tracking these strategies comprehensively.

Glossary of Terms

Covered Call: A strategy where an investor sells call options against stock they hold, generating premiums from the sale.

Long-term Equity Anticipation Securities (LEAPS): Options with expiration dates longer than one year, generally allowing more control over volatility and timing.

Out-of-the-Money (OTM): A call option with a strike price above the current price of the underlying asset. It does not offer intrinsic value.

In-the-Money (ITM): An option that has intrinsic value; for a call, this means the strike price is below the current price of the underlying asset.