Market Beat: Options strategies for stock investors
March 7, 2018
Options are tools that stock investors can use to help manage their investment portfolios. Using options requires quite a bit of sophistication and they are certainly not suitable for all investors.
There are two types of options: puts and calls, and they can be combined in a variety of ways to produce different outcomes. If you own a put, that gives you the right but not the obligation to sell your stock or ETF at a set price by a certain date. Conversely, if you own a call option that gives the owner of the option the right but not the obligation to buy a stock or fund.
One of the most popular options strategies is known as the covered call. The covered-call strategy consists of buying a stock or fund, then selling a call option. When you sell a call option you become obligated to sell your underlying stock at a set price by a certain date. In exchange for being willing to sell the stock you receive a payment known as a premium. What you do is purchase the stock and then decide a higher price that you're willing to sell at a set date in the future. The premium that you receive is yours to keep.
The premium you are paid also provides a little bit of downside protection. One disadvantage to the covered-call strategy is that in exchange for receiving the premium you limit your upside potential.
For example, say you buy ABC stock for $100 per share and are willing to limit your upside to a 12 percent annual return, you could sell a one year ABC $110 call for $2. If ABC was called away from you at the expiration date you'd get $110 for the stock plus the $2 option premium for a 12 percent return. If ABC was below $110 at the option expiration, you'd keep the stock plus the $2 call premium. In the event that ABC paid a dividend, the investor would collect the dividend income as well.
So, if the dividend yield on ABC stock was 4 percent, now the total return for the best case scenario would be 16 percent, after you add in the dividend yield.
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Writing call options on dividend paying stocks or exchange traded funds can be a good income producing strategy for fairly sophisticated investors.
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.