Market Beat: Using options to manage your stock portfolios
August 1, 2012
TRUCKEE, Calif. andamp;#8212; There are several ways that options can be used to manage stock portfolios. Options are also popular with traders and speculators so itandamp;#8217;s common for many investors to think that options are primarily a high-risk tool for speculation. That is not true. Options can also be used to lower risk and enhance return or produce income from a portfolio.An option is a contract that gives the owner the right to buy or sell a certain stock at a set price. There are two types andamp;#8212; calls and puts. A call option gives the owner the right to buy, and put option gives the owner the right sell. They are issued on weekly, monthly and even an annual basis. There are two parties to each option. One is the buyer, also known as the holder, and the other party is the holder who is also known as the writer. While the buyer has the right to buy or sell the stock at a set price, the seller is obligated to buy or sell. The popular covered call strategy consists of buying a stock, then selling a call option on that stock. The strategy produces immediate income and provides for some downside protection in the event the stock declines in value. There has been quite a bit of serious academic research done on the covered call strategy, and the research shows that call writing can enhance returns and lower risk. It is especially effective for producing income in todayandamp;#8217;s record low interest rate environment.Another strategy that can be effective is selling puts with the intention to buy the stock if the stock falls to your target. The investor collects immediate cash for selling the option. The cash that is required to purchase the stock then sits in the account waiting to see if the stock will fall to the desired entry price. If the stock stays above that price, the option will eventually expire worthless, and the premium collected for selling the option is kept by the investor.Substantial annual returns can be collected by using a consistent strategy of selling cash-secured puts, then buying the stock or ETF at your target price, then by starting a covered call strategy once youandamp;#8217;ve bought the underlying stock.Kenneth Roberts is a Truckee based Registered Investment Advisor. Information on his money management service can be found at http://www.fusiontargetretirement.com or by calling 775-657-8065. Past performance does not guarantee future results. Consult your financial adviser before purchasing any security.