Selling DraftKings Options - How and Why
Plus, a free step-by-step guide to selling calls against your stock and cash positions.
This service is for general informational and educational purposes only and is not intended to constitute legal, tax, accounting or investment advice. These are my opinions and observations only. I am not a financial advisor.
DraftKings stock (ticker DKNG) has been struggling and after touching $20 per share it has been in a downtrend. I do like DKNG for the long term and own shares, but the technicals are the technicals (reading the chart) and I need to see the stock price at $24 before I get too excited about a recovery and potential bull run, the uptrend.
So, how am I making money with these shares in the meanwhile? Selling options, specifically covered calls, and raking in the cash. This is something you can do if you own 100 shares of any stock.
Selling a covered call simply means selling a call option and receiving cash for it in exchange for the obligation to sell your shares at the call option strike price.
Simply put, you are selling call options that are only valuable if the stock moves up further in price at which point you are enjoying both the cash you received and a portion of those stock gains.
You’re giving up the potential for big, big gains in a short amount of time for the guarantee of locking in 3-5% profits. This is the essence of the covered call strategy.
If you don’t own 100 shares of a stock yet, that is ok. Later, I will get into how to pick up those shares and at a discounted price. But first, if you do own 100 shares of DKNG, here’s why I think now is a time to consider selling DKNG options.
Technical Reads, Headlines, and History
The 2023 chart for DKNG is nothing short of beautiful. That said, it has only been one month. A really fantastic, very green (positive) month to start the year.
It has been an impressive push from stock price lows near $11 to where it sits at the time of this reading, just above $15 per share. However, if you zoom out to capture the last three months of 2022 it becomes clear that maintaining a price above $15 has been difficult for DraftKings.
The chart at the start of this newsletter highlights the multiple rejections at this resistance level (price level that stops momentum of the stock). After a quick move up to $14.72 there has been a battle going on, stalling out the candles (stock price) below the $15.26 level.
The question now is, do we get a bit of a sell off after such a tremendous rally which would drive the share price down or do we merely pause for a moment at the $15.26 resistance level before continuing to higher prices for DKNG?
Financial news headlines have been positive as GDP (Gross Domestic Product, measure of U.S. economic activity) was strong, unemployment remains low, and people continue to spend. Positive news across the board.
My read on this is, the pressure to hike rates has increased and the Fed (U.S. Federal Reserve) is likely to put a damper on this rally by announcing a 0.50% hike this Wednesday.
You may have heard about the Fed raising rates. This is no surprise. And whether you understand the reasons or not, you should know that rising rates typically make it tough for stock investing.
So, while the market seems to have priced in a hike of only 0.25% we could see a higher than expected rate hike of 0.50% which would be negative for markets overall.
This is important because just as the markets and stocks like DKNG are reaching critical levels, the Fed announcement could cool things off quickly. I have been talking about $410.49 being a key resistance level for ticker SPY (S&P500 ETF, tracks the S&P500) and it hit $408 last week before backing off.
What I mean by this is, to show any signs of an upward trend forming the price of SPY shares need to close above $410.49. The price action this week and the FOMC (Federal Open Market Committee) meeting which is when we will hear about the rate hike, will determine a quite lot I think.
History has also shown a propensity for volatility for DKNG around the big game in February (the Eagles are my pick to win it). If you look at early February for the past two years you will see big price moves up followed by selloffs in the stock driving the price back down.
In 2021, DKNG ran from $44.10 at the start of the year to $64.78 by February 8th, a 47% increase! From that high point it quickly sold off to $52.67 before month end, a drop of 18%. By the middle of May it managed to get as low as $40.
In 2022, the stock moved from $17.41 in late January to a high of $24.73 by February 11th, and again sold off on an earnings report a week later to below $17 per share. By the middle of March, the stock price almost touched $15.00. Again, after a roaring start and big gains the stock sold off and ultimately ended up lower than it started.
History is never guaranteed to repeat and past experiences do not ensure future results. However, I do think having history on your side when trading is positive overall, and it is worth noting this past performance.
How to Sell Covered Calls - DKNG Example
Referring back to the original chart, the ideal time to sell covered calls against a stock position you own 100 shares of is when that stock is bumping into resistance or right after it drops after this period of testing resistance.
For a more general list of the rules that I follow for selling covered calls, the latest post that outlines this information is Turning $2,383 into $1.4 Million Selling Options. But let’s dive into an actual example with DraftKings, step by step.
Step 1: Identify resistance
We’ve already done this for DKNG, noting that $15.26 is the key resistance level we would like to see hold in the short term. I like to sell call options that are close to or above this resistance level which will help improve the probability of the calls expiring out of the money and worthless.
Quick explanation: Call options are valued based on the difference between the stock price and the option strike price (among other things). So, if the option expires on February 10th with a strike price of $15 the stock would need to be above that strike price by February 10th otherwise the option is considered “out of the money” and worthless upon expiration. If it closed at $16 per share, the option with a $15 strike price is “in the money” and is worth $100 at expiration ($16 - $15 = $1 x 100 shares = $100).
Step 2: Identify the call option
We have established a resistance level of $15.26 and now need to review which calls to sell. I like to ensure I collect no less than 3% of my stock position (the 100 shares) for every call sold that expires in approximately 30-45 days. For DKNG, at $15 per share that equates to receiving no less than $45 over 45 days, or $1 per day.
I will accept less for shorter durations, but I try to make sure the math works out such that I am able to collect close to the 3% every 30 days. Also note, this math doesn’t account for the move in the stock’s price, I am only referring to the price of the option.
Step 3: Sell the call and collect the premium (cash)
Once you have identified the strike price and duration, all you have left to do is sell the call option. Taking a look at the option prices at the time of this writing, I like considering the $15.50 strike price and 3 Feb 23 expiration which at close Friday would bring in $40, or about 2.6% in just one week!
Another quick note: Option contract prices effectively list how much per share you must pay (when buying an option) or recieve (when selling). Each contract is for 100 shares so the math works out that for a $0.40 contract you actually pay/receive $40 (100 x $0.40 = $40.00).
You may not want to sell a call option with a strike price so close to the current stock price. This is understandable because you are risking your shares being called away if the stock price keeps rising (the benefit of owning a call option is you may collect the shares at any time before expiration).
When an option owner wants to purchase shares at the strike price of the option, they may exercise the option which causes them to buy the 100 shares at the strike price listed and the seller receives the cash for selling the stock.
I personally am not worried about my shares being called away. I am utilizing this strategy of selling covered calls purely for the gains. I am buying companies that I would hold for the long term, and intend to, but I’m comfortable with the shares being called at any time in exchange for the premium I collect.
If you would like to increase the odds of keeping your shares you can move up your strike price. The $16 strike price allows you to collect $25 for the 3 Feb 23 DKNG call option which is still 1.66% in just one week.
The process is repeatable even if your shares are called away. In this example, assume the shares were theoretically purchased Friday for $15.04 (closing price) and a call with the $16 strike expiring 3 Feb 23 was sold, collecting $25 immediately.
If the stock price rose above $16 and your shares are called away, you’ve made both the gains on the shares up to $16 plus the $25 collected from selling the call. That is a gain of 8% in one week with zero risk of losing money on the call you sold.
One last note, you are able to “buy back” the option you sold. You do not need to wait for the option to expire. For example, if the DKNG share price drops to $14 at the open on Monday the call option might drop to be worth only $5. You could buy it back at that price and net the $20 profit ($25 sell price - $5 buy back price).
I explain the benefits in more detail in my previous newsletters because I think it is powerful. You are collecting cash while the stock moves sideways or down. You can reinvest this cash and enjoy the power of compounding while others are watching and waiting and doing nothing.
Risk
There is risk involved when buying shares and selling covered calls, just as there is with any investment or trading strategy. The good news here is you know exactly your risk and it all lies with the shares of stock you own.
The covered call strategy requires you own stock which inherently means you are taking on the risk that the shares you own could drop in value. This is why the stock selection part of the process is both very important and personal.
You must find the right stocks for you. Do your research, ask questions, and take your time before putting your money to work. When you are ready, dive in with the knowledge that you are letting your money make money for you.
That being said, if your shares drop to zero you will not be able to sell any calls against them. And if they drop significantly, you will not be able to collect as much premium.
I personally like the covered call strategy because of what I perceive to be lowered risk associated with it relative to other strategies with similar or even lesser potential possible returns. Rather than trying to buy at the right time, the focus now is on selling at the right time to maximize gains.
Unlike buying at the wrong time, selling covered calls at the wrong time does not mean you lose money. It means you might miss out on additional gains, and that you could have earned more, but you are not losing money.
You are locking in a guaranteed profit in exchange for a cap on your gains and if you do it poorly, you simply collect less.
Using Options to Buy DKNG Shares at a Discount
If you do not own 100 shares of a stock but are planning to buy, you can use a cash secured put strategy. Using DKNG as the example again, instead of buying 100 shares at the current price of $15.04, you can hold the cash and sell a put that obligates you to buy 100 shares at the strike price you select.
Here is how it works.
Assume you would like to buy 100 shares of DKNG for $14.50. You can sell a put contract that obligates you to buy those shares at exactly $14.50, but you must hold the $1,450 that would be used to buy those shares in your account until the put expires or until you “buy it back.”
Similar to selling call options, you can buy back your put options to close your position. This will free up the $1,450 you have locked up by selling the put contract.
The premium you collect by selling the puts is the “discount.” What I mean by this is, if you had simply bought the shares at $14.50 you would have paid $1,450. But when you consider the cash collected from selling the put contract, let’s say you collected $50 for selling the 10 Feb 23 puts, you can discount the overall price paid for the 100 shares by the amount collected ($1,450 - $50 = $1,400).
Once you have sold the put option your risk is twofold. If the stock drops drastically, you are still obligated to buy it at the strike price. So, if bad news comes out and the stock drops to $10 per share but you sold a put with a $14.50 strike price, you are now paying $1,450 for $1,000 worth of stock.
The other risk is not a hit to you financially but instead is about giving up on potential gains. If you sell a put and the stock starts rising, you do not own the stock and therefore miss out on the gains.
There are certain situations where I might utilize this method but overall, I prefer the simplicity of the covered call strategy.
I hope you found this information useful. I will continue to post ideas on Twitter for stocks I consider to be in ideal spots for buying shares or selling calls. I also highlight which call options you might consider selling and why.
If you have any questions, be sure to find me on Twitter @tradernatehere and I’ll reply to your DMs as quickly as I can.
Also, be sure to follow for daily posts on trade updates and trading strategies as I pursue my goal of educating thousands on the many ways trading options can help build your account.