Market Beat: Options could be a good call for stock investors
One of my all-time favorite stock market quotes came from Will Rogers, when he said, “Don’t gamble, take all of your savings, buy a good stock, hold it until it goes up, then sell it. If it don’t go up, don’t buy it.” Sounds nice and simple, but I don’t recommend following that advice. I like doing things like diversifying, and using other portfolio management strategies.
Options are tools that can be helpful management tools for stock investors. Options are not suitable for all investors, it is very important to thoroughly understand how they work.
There are two types of options, puts, and calls. They have different expiration dates and a wide variety of strike prices. They’re available for individual stocks and exchange-traded funds and notes.
If you own a put, you have the right but not the obligation to sell your stock or fund at a certain price by a set date. Owning a call option gives the owner the right to purchase the underlying stock or fund at the strike price by the expiration date.
If you decide to sell a put you’ll be obligated to buy the underlying stock or fund. Selling cash-secured puts can be a good strategy to obtain decent returns if you’re willing to accumulate a position in a stock or fund. The primary disadvantage is that you’ll be exposed to the full risk of stock ownership and the return is limited to the premium received for selling the put.
Puts can also be purchased to protect a stock or fund. Put options can provide insurance for your portfolio but are similar to buying insurance for your home, they cost money and you may not need them if the market goes up.
Selling call options can be a viable income producing strategy. If you own a stock or optionable exchange-traded fund you can collect some money by selling calls and giving someone the right to buy the stock at a higher price. A disadvantage to the covered call strategy is that you limit your upside potential in return for receiving the certain call premium. Combining dividend-paying stocks with covered calls can produce some decent cash flow for income investors.
Calls and puts can be combined in a strategy known as a collar, which limits the upside and the risk to the downside. It’s very important to understand how options work before using them.
Kenneth Roberts is a Truckee-based Registered Investment Advisor. Information is at his blog at http://www.sellacalloption.com or 775-657-8065. The mention of securities should not be considered an offer to sell or solicitation to buy investments mentioned. Consult your investment professional to understand the risks and/or how the purchase or sale of these investments may be implemented to meet your investment goals. Past performance is no guarantee of future results.