By Jay Soloff
Greetings from the Las Vegas MoneyShow! This event is always one of my favorites to speak at every year. It’s a great place to meet with other options traders or traders who are looking to learn how to start using options.
This year I’m presenting primarily about overwriting (selling options in conjunction with owning stocks) and volatility trading. I want to take this opportunity to discuss overwriting a bit more as I feel it may be the most powerful use of options available to traders and investors.
Generally speaking, options overwriting takes two forms: covered calls and cash-secured puts. Covered calls involve buying stock and selling calls against the shares (at the same time) to generate income while still allowing for price appreciation in the stock. Cash-secured puts utilizes selling puts (fully secured by available cash) to generate income and potentially set a more attractive entry point to buy shares.
I tend to focus on covered calls as I feel they are bit more intuitive to new options traders than cash-secured puts. Owing the stock allows you to make money if the stock goes up (to a certain extent) and still collect a dividend if there is one. Selling a call against the shares provides income in return for capping the growth potential of the stock.
What makes covered calls so attractive is how low risk they are. The strategy is actually less risky than owning stock by itself because of the additional cushion you get by collecting income from the calls. Meanwhile, you can earn a monthly return akin to a dividend, but often times with a much higher yield. Plus, there is often still room for the stock price to appreciate.
Let’s look at a real example which just came across my trading screen.
A covered call trader purchased 100,000 shares of Starbucks (SBUX) while selling 1,000 June 21st calls against those shares. The stock was trading at $77.75 at the time, and the calls were at the 80 strike and sold for $1.00 in premium.
Breaking this trade down, the $1.00 received for selling the calls means the trader is protected down to $76.75 in the stock. That dollar also represents a 1.3% yield in under 6-weeks (annualized it would be 11.3%). At the same time, the position and still earn $2.25 in share price upside before being capped, or 2.9% gains.
All told, the trade can earn 4.2% max gain in under 6 weeks. At the same time, the shares are protected down to $76.75 during that period. It’s easy to see why these trades are so popular. Generate additional income, keep some upside potential, and protect some of your downside risk – all in one trade.
Looking at the chart, you can see why SBUX makes for a good covered call candidate. The market turmoil this past week so far hasn’t caused the share price to dip. Meanwhile, the climb in the stock price has been slow and steady. These are nearly ideal conditions for this type of trade.
You are never too old to learn some new investment techniques that can enhance your portfolio returns. '10 Simple Rules To Trade Options Like A Pro*' from our friends at Investors Alley is a good quick overview on using option strategies to mitigate risk and enhance returns in your portfolio. These strategies are well suited to high beta sectors like biotech where option premiums tend to be large. The report is now available* free via download HERE