Tahoe-Truckee Market Beat: Option strategies for long-term investors
Options are tools that can be employed in a variety of ways to help control risk and enhance the return of an investment portfolio.
Options can also be risky and are certainly not suitable for all investors. If you’re considering using an option strategy, be sure you understand the risks and potential rewards.
There are two types of options — puts and calls. If you buy a put, you have the right but not the obligation to sell the underlying stock or fund at a certain price known as the strike by a set date, known as the expiration date. If you buy a call, you have the right to buy the stock.
Buying puts can provide portfolio protection, because it gives you the right to sell your stock at a set price. The downside is that they cost money, and if you don’t need them, it is kind of like buying insurance — you hope you never need it, but you’ll be glad you have it if the house burns down.
Buying calls can give you exposure to the upside potential of a stock, but your risk is limited to the price you pay for the call. If the stock goes below the call’s strike price, the call option will be completely worthless at the expiration date.
If you sell a put, you’ll be obligated to purchase the stock at the strike price by the expiration date. When you sell an option, you receive the premium for the option, and if the price of the underlying stays above the strike, the option will expire worthless and you keep the premium you’ve received.
Selling puts can be a good way to accumulate a stock or ETF, but you’ll be exposed to the full risk of the stock ownership with limited return potential.
Selling calls can be a good way to earn some extra income on stocks you hold. If you own a stock and sell a call option on it, that is called a covered call.
If the stock rises above the strike price, you’ll have to deliver the stock at that price. Selling calls limits your upside potential in return for receiving a set premium. If the stock stays below the strike, the call expires worthless and you keep the premium as income.
There have been numerous academic studies done showing that options can lower portfolio volatility and enhance returns.
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.