Hi everyone and Merry Christmas! Here is another article from Barrons’ that discusses selling options as a way to increase your portfolio return in these trying times. Enjoy and I hope all of my readers a Happy New Year!
Have a great week,
Dave
A Holiday Gift for Traders
By STEVEN M. SEARS
By using a strategy known as overwriting, the options market will pay you to buy or sell stocks.
The buy-and-hold strategy has legions of fans. However, an options strategy, known as overwriting, often does better.
By selling bullish calls, or bearish puts, against stocks that investors own, or want to own, investors can boost returns with little risk. The strategy often outperforms the standard buy-and-hold approach because it increases income earned from stocks.
The money received for selling the put or call, however, is a conditional dividend as investors must sell the stock at a higher price if a call is sold or buy the stock at a lower price if a put is sold.
The key risk with overwriting is that if a stock plummets, and you own a loser at a higher price denoted by the put’s strike price, or the stock surges, you miss out on any gains above the call’s strike price.
Many strategists are increasingly recommending that investors overwrite their portfolios to enhance returns. The implied volatility of many options is elevated due to lingering global economic concerns and Europe’s sovereign-debt crisis. By selling calls, or puts, investors can benefit from the fear of other investors, and use that fear to more cost-effectively buy stock or increase returns.
“All investors are struggling with high market volatility and elusive returns. Selectively selling options lets investors overcome those hurdles,” says Michael Schwartz, Oppenheimer & Co.’s chief options strategist.
On Thursday, for example, Schwartz advised his clients who own emerson (ticker: EMR), an electric equipment stock, or want to own the stock, to think about selling puts or calls. Consider the Emerson trade a case study that can be used with any stock.
With Emerson at $46, Schwartz likes selling the January $50 call that expires in 2013 at $4.40. Emerson pays a $1.60 dividend. If the stock price does not rise above $50 before the call expires, investors pocket the $4.40, and earn a 14% return. If the stock exceeds the call’s $50 strike price, they are obligated to sell the stock, and they will receive a 21% return.
Conversely, Schwartz also likes selling Emerson’s June $46 put for $4. If the stock advances, investors keep the $4 received for selling the put and earn a 9.5% return. If the stock declines below $46, investors are obligated to buy the stock, though the cost is defrayed by the $4 received for selling the put.
Many savvy investors have made overwriting a regular feature of their investing discipline. Depending on their view of a stock, they sell calls if they think shares are under pressure and unlikely to advance. If they think a stock will advance, they sell puts.
In essence, overwriting lets investors take advantage of the fear and greed that pulsates in the market. It is a clever approach, and one worth mastering.
