Saturday, 12 October 2013

Great Option Strategy Resource

One resource I use to study/learn more about Option strategies is the OIC website, the Options Industry Council.

They have a decent website explaining the various advanced strategies you can do with options.

Now, options are derivatives and generally leveraged in some way, shape, or form so they are very dangerous tools if you don't know what you're doing (hence why the link).  But much like a knife, its invaluable once you learn how to properly use it!  Most people are only familiar with basic buy/sell of calls/strikes but there's a whole range of strategies you can use to either profit or reduce risk.

Example:  Cash-secured Puts


The cash-secured put involves writing an at-the-money or out-of-the-money put option and simultaneously setting aside enough cash to buy the stock. The goal is to be assigned and acquire the stock below today's market price. But whether or not the put is assigned, all outcomes are presumably acceptable. The premium income will help the net results in any event.

The investor is bullish on the underlying stock and hopes for a temporary downturn in its price. If the stock drops below the strike, the put may be assigned. That would allow the put writer to buy the stock at the strike price. The effective purchase would be even lower: strike price less the premium received.

There are two principal risks. First, the stock might not only dip but plummet well below the strike price. The investor must be comfortable with the strike price as an acceptable long-term acquisition price, no matter how low the market goes.

Why would you ever want to do this?  Suppose you like a company's long term growth prospects and expect a short pullback.  Or you like it but not at its current price.  You can either buy right now or sell a put to purchase the stock at a lower price.  

By writing a cash-secured put, you get paid a small premium and if the stock drops below the strike price, you can get assigned the stock, essentially purchasing the stock at the lower price + the bonus premium.  The only risk is that the stock continues going up and you miss out on the stock appreciation.  


Let's look at a real example.  Apple is currently trading at $492.81 per share, a significant increase over some of the lows just 3-4 months ago when it hit $380.  You like Apple because of its long term prospects (15% 5Y EPS forecast), its strong cash flow, good dividend (2.5%), and low valuation (~11-12 PE).  But you don't want to buy near its current high because there's a possibility of it dropping or because you want it at a better price.

Looking at its Nov 16 put option at $485 strike, each contract is selling at $16.3.  So lets sell 1 contract, profiting a handy $1630.  Now you wait until expiration.  At expiration on Nov 16, there's 2 possibilities:

1) Apple is trading at >$485.  What happens?  You profit $1630 and you go home.  No loss, nothing, you made a decent amount and that's it.  

2) Apple is trading at <$485.  What happens?  You keep your $1630 and you get assigned 100 shares of Apple at $485 (hope you got that $48.5k cash sitting around).  End result, you got into Apple at a better price than the $492.81 it's at today and profited $1630 to boot.  This means you essentially purchased Apple at $468.7 ($485 - $16.3).  So for practically nothing, you got a 4.9% discount to Apple's current going price.

So what's the downside?

Well, the main one is that if Apple doesn't drop below $485 at strike and continues going up instead to say...$550.  Well you missed out on the upside.  You would've profited only $1630 instead of the normal stock appreciation from buying at $492.81.  This is lost opportunity cost but NOT capital loss.  While mathematically its the same, for most people (esp risk adverse investors) its not as they would rather miss out on opportunity than suffer capital loss.  I can understand that to some degree.

What about the downside if Apple continues dropping below $485?  In this case, since the goal comparison is BUYING Apple at current price of $492.81, you would've lost the same amount (less if you include the $1630 premium) and thus there's not much of an additional downside risk.

This is a relatively simple options example but can show how proper use of options can be extremely beneficial as a risk/reward strategy.          


1 comment:

  1. 非常に有益でレビュー。私はこの記事accrossなってきたことを嬉しく思います。私は熱心にそのような情報を与えるポストを探していました。がんばり続ける。
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