A challenge for investors is to generate returns in light of low interest rates and deteriorating economic growth.
Ideally an investor would buy quality stocks and hold them in a portfolio. These times are clearly less than ideal. Investors who want to persevere need new ways to increase returns and minimize risk.
An opportunity exists in the options market. The sale of well-placed puts and calls generates a dividend-like payment from the options market. The condition of this payout is that investors must be willing to buy the stock at a lower price, or sell the stock at a higher price, which is the fundamental tenet of successful investing.
Some critics will say it clouds investing with some complexities and expenses of trading. But it can position investors to increase returns, lower the price of stocks already owned, and manage risk.
Selling cash-secured puts is ideal for an investor who would like to acquire shares in a particular security, but is willing to wait for them to trade at a target price that is below current market level.
Writing Covered Equity Calls is appropriate for an investor who wishes to generate income in addition to any dividends from shares of underlying stock owned. They must be willing to limit upside profit potential on a specific stock holding in exchange for limited downside protection. Generally the investor is neutral to moderately bullish on the investment owned.
Consider Apple (ticker: AAPL) at $675 on Aug. 27. Investors who want to buy the stock, or already own shares and are willing to buy more at a lower price, could sell Apple’s January $665 puts for $44.50. The strategy is known as a put-write. If Apple’s stock rebounds and trades higher, investors keep the money received for selling the put. If Apple’s stock declines below $665 (the put’s strike price) investors must buy the stock for $665. The purchase price is effectively lowered by the amount of money received for selling the put ($44.50) to $620.50.
Selling calls against stocks already owned is known as over-writing or a covered-call strategy. With Apple’s stock at $675, investors who own the stock can increase returns and modestly hedge against a decline, by selling January $700 call for $37.50. If the stock advances above $700, investors are obligated to sell the stock. If the price remains below $700, investors keep the money received for selling the call.
Sell puts and calls that expire in three to six months. Those expirations tend to be actively traded since many investors repeatedly sell options against their stocks. Options that expire in three to six months also tend to trade at $1 or more, which is the minimum amount many investors want to pocket when trading options against stocks.
A CPA or CFP can assist you in evaluating option strategies. Make sure you can find a professional with experience in executing these tactics.Information provided by Steve Forrest, MBA, CPA/PFS, CFP® and Pete Deacon MBA, CPA, CFP®, Forrest Financial Services, L.L.C., Windsor Heights, www.forrestfinancialservices.com, 277-3495.