Tahoe-Truckee Market Beat: Option strategies for stock investors
August 22, 2016
Louis Pasteur once said, "Fortune favors the prepared mind." That quote applies to investors. It's very important to have a plan in place and don't let emotions take over. Know what tools are at your disposal to help you achieve your goals.
Options are not suitable for all investors, but when applied properly can be useful to control risk and enhance income from investment portfolios.
Put options can be purchased to protect positions. The buyer of a put contract has the right, but not the obligation, to sell the underlying stock or fund at a set price, known as the strike price, by a certain date known as the expiration date. Buying put options is kind of like buying insurance on your home, if the house burns down, you'll be glad you had it, but you hope that you'll never need it.
If there's a stock or ETF that you'd be willing to purchase at a lower price, you can sell put options and collect some premium while you wait for the underlying investment to drop in price. If you sell a put you'll be obligated to purchase the stock at the strike price.
Call options can be bought if you'd like to participate in the upside movement of a stock, but have risk limited to the price you pay for the call option.
One good strategy in a normal interest rate environment is to purchase Treasuries and then use the interest from the Treasuries to buy index options; that way you participate in the upside of the market, but your worst case if the market drops is that you'll lose the interest from your Treasury bonds.
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Selling call options against a stock holding is known as a covered call and can be a viable income producing strategy. Academic research has proven that call writing can enhance returns and lower the volatility of the underlying investment.
A protective position known as a "collar" can be created by selling a call option and using the premium collected to purchase a put option. That way, you'll limit your upside potential, but also limit the downside risk with the put option and the cost of the put is offset by the money received from selling the call option.
Some sophistication is required to use options, but they can be excellent tools for portfolio management.
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.
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