I’ve written many articles highlighting the advantages options trading and how this technique, when deployed in opportunistic or conservative scenarios may augment overall portfolio returns while mitigating risk in a meaningful manner. Here I’d like to focus on leveraging cash-on-hand to engage in options trading, more specifically selling covered puts. In laymen’s terms, I’ll cover option variables, an example, strategy and empirical results with commentary.
1. Why buy a stock now when you can purchase the stock in the future at a lower price while being paid to do so?
2. Why buy stocks at all when you can make money on the underlying volatility without ever owning the shares?
Timing the market has proven to be very difficult if not altogether impossible. However creating opportunities to lock-in downward movement in a given stock one is looking to own is possible. If a stock of interest has substantially fallen to at or near a 52-week low, then one has an option to “buy” the stock at an even lower price at a later date while collecting premium income in the process. Alternatively, it's also possible to make money on the option itself without owning any shares of the company via realizing options premium gains as the underlying stock appreciates in value off its lows. This is called a covered put option, covered in the sense that one has cash to back the option contract. Leveraging covered put options in opportunistic scenarios may augment overall portfolio returns while mitigating risk when looking to initiate a future position in an individual stock. In the event of a covered put, this is accomplished by leveraging the cash one currently has by selling a put contract against those funds for a premium. It's also possible to make money on the option itself without owning any shares of the company via realizing options premium gains as the underlying stock appreciates in value. [Read more...]