I wrote a report entitled The One Conservative Investing Strategy Every Investor Should Use But Hardly Any Do. You can read it for yourself under the "Reports" section, then click on "Options".
Options are truly one of the best total return enhancers available to investors. You need to be careful however, since the there are two sides to this wealth building market, and one sides odds of winning is much greater than the other.
The Options Market
Options give investors the right, but not the obligation to buy or sell a particular security at a predetermined price, at a predetermined date. There are basically two sides to an option:
1. Buyer - the speculative side
2. Seller - the conservative side
The buyer is taking money out of their pocket hence speculative. The seller is putting money in their pocket hence conservative.
Buyer - A buyer of an option is best described as a gambler. Similar to someone putting coins in a slot machine, the option buyer is hoping for the big payoff. When purchasing an option, the odds of losing are 80% ｱ. The buyer is betting a stock will rise or fall to a particular price within a particular time frame. If the buyer is wrong about the direction or the time, a loss will result. While some investors buy options to hedge their portfolios, others gamble.
Seller - A seller of an option is interested in cash flow. The seller basically accommodates the gambler. Since the buyer puts money in the slot machine, the seller plays the role as the slot machine. When an investor sells an option, the odds are they will win 80% ｱ of the time. The seller is not looking for the big payoff, just a smooth steady income stream. The seller is willing to sell stock that they own at a higher price than is currently quoted, and is willing to buy a stock at a lower price than currently quoted. Makes sense doesnt it?
There are basically two types of option sellers:
1) Call Seller - The call seller is hoping a stock they own will go up, and in some cases do nothing prior to expiration. To take the risk that the owner of a stock may have to sell the stock at a profit, the seller receives a cash payment.
2) Put Seller - The put seller is hoping a particular stock will decline in value to a particular price so they can purchase it. To take the risk that they may have to buy a security at a price in which they want to own it, the seller receives a cash payment.
Today, we want to sell some calls on 5 of our stock positions. On some stocks, if we are called away, we will be selling our stocks at our near their 52 week highs. On other positions, we want to force the stock to deliver gains since the price action has been rather muted.
Here are some call selling ideas:
Sell the Sunoco May 85 call (SUNEQ) @ 1.85: This will give you a gain of 7.51% or 30% annualized.
Sell the Bank of America 47.5 call (BACEW) @ .75: Gain potential= 12.36% or 16.47% annualized.
Sell the J.P. Morgan May 42.5 call (JPMEV)@ .70: Gain potential= 25.21%
If you want to go a little farther out:
Sell the J.P. Morgan June 45 call (JPMFV)@ 1.00: Gain potential= 33.3%
Sell the Chesapeake Energy May 32.5 call @ .90: Gain potential= 2.61% or 3.91% annualized
Sell the Valero May 62.5 call @ 1.65: Gain potential= 13.31% or 53.2% annualized.
*** Regarding how we arrived on our gains... We took the price we paid for the stock + the options premium= the total gain would include the capital gain in the stock, plus the option premium. Stocks like BAC & JPM have been held for 12 months, where SUN, CHK, and VLO were held less than a year.
Of course, if the stock is not called away, the income recieved from the option would be the only gain which would differ depending on the option premium received. IE- SUN @ a premium of 1.85, and a cost basis of $80.36, would give us a gain of 2.3%.
Comments (1)
Can you show how you derived one of these gain %'s? I tried working the numbers out myself and was coming up with different % gains.
Also, if you sold a call wouldnt you want the stock to rise, but not above the strike price?
Posted by RC | March 28, 2006 2:31 AM
Posted on March 28, 2006 02:31