An Options Strategy That Beats Dividends

Learn a better way to generate income than buying dividend stocks

   

Here’s some options trading information you can use. For the longest time, the prevailing thought for making money in the stock market was to buy and hold. Over the last several years, this “strategy” has not only come under scrutiny, it has pretty much been debunked. The buy-and-hold strategy has shown to not work … period.

Now, as is always true in the market, there are no absolutes. There are examples of stocks that have improved over time and have had a decent return. But there are not a lot of them. Looking at stocks like General Electric Company (NYSE: GE), Intel Corporation (NASDAQ: INTC) and Microsoft Corporation (NASDAQ: MSFT), we find that over the last 10 years, most stocks have lost value not even taking inflation into account.

The ones that have bucked this trend have been stocks like The Procter & Gamble Company (NYSE: PG) and Johnson & Johnson (NYSE: JNJ). These are larger, highly stabilized stocks that, most importantly, pay a dividend. Actually, it has been argued by some and supported by some empirical data that the only growth in the Dow and other indexes is due to dividend growth. If this is true, than dividend growth should be examined further.

For the record, dividend growth is a form of income generation that can be found in the stock market. Investors would be best advised to look to incorporate income generation strategies like dividend growth into their portfolios.

But even with the dividend growth strategy, there is not a lot of profit to go around. It seems that most that have done well in the market have done it by picking individual stocks to buy and sell back and forth relying on market timing for when to get in and out. But these people have the time and willingness to be in front of the computer all day, every day. This can really only be done by someone who considers themselves a full-time trader. This definition does not fit the vast majority of investors. So, true investors must find another way to succeed in the market on a consistent basis.

This takes us back to the supposed success of the dividend strategy via income generation. The problem is that the dividend strategy is just not powerful enough or consistent enough. Not all stocks pay dividends and of the ones that do, most barely outperform inflation. So maybe the dividend strategy is not the answer but a hint to the answer. Maybe it’s not the dividend strategy, but the idea of income generation that is the secret.

Following on this lead, there is another way to generate income in the financial markets that is far more powerful and consistent than dividends, and can easily outperform inflation. It is located in the options market and called premium collection.

Premium collection is the art of capturing the decaying extrinsic value in an option over the passage of time. There are several option strategies that allow one to collect premium on a monthly basis that are safe, cost efficient AND provide very good monthly returns!

Nowadays, with income generation more important than ever, and for more reasons than ever, investors desperately need to learn how to master the technique of income generation through premium collection in the options market. By mastering this technique, you can not only increase your portfolio but can also generate income to be used in other areas, for other things. Of other interest, premium collection strategies are high-probability, low-cost, low-adjustment trades. In other words, great for those who are not professional traders.

Income generation is it really fits the greatest number of investors — those who do not have a lot of time to spend watching the market all day every day, those who do not have big accounts, and those who can’t afford to take big risk. If you as an investor fit into one or more of these scenarios, then you should definitely spend the time, effort and energy to learn about premium collection.

There is great potential that as our economic situation becomes clearer over time we may see a market that stagnates dramatically for a pretty substantial amount of time. If the scenario plays out that way, we may find ourselves in a situation similar to that of Japan. If it happens, the only way to make money in a consistent, high probability way will be premium collection.

How Premium Collection Works

An option’s price consists of two different values. There is intrinsic value, which represents the amount by which the option is in the money. This value is tied directly to the stock price and does not decay over time. Not all options have intrinsic value (because not all options are in the money).

The other value, the amount over intrinsic value, is known as extrinsic value. It consists of time and volatility, and will decay over time. The amount of extrinsic value in an option differs from option to option with the at-the-money options having the most extrinsic value.

Added to this is the rate of decay of the extrinsic value known as theta. Extrinsic value decay is not a linear function. Option price decay (theta) increases as expiration draws closer. Thus, the highest rate of decay exists in the front (current) month options.

In order to capture this decaying extrinsic value, an investor must sell an option. This can be a risky thing as selling options brings the investor an unlimited potential risk.

However, there are some option strategies that are specifically designed to allow an investor to capture a high percentage of the decaying option safely by purchasing another option with a much lower rate of decay to hedge the sold option with the greater amount of decay. In essence, we are giving up some of the income we are generating in order to neutralize the unlimited loss scenario.

Strategies like the time spread, butterfly, condor, and even the vertical spread are ideal for this situation. Constructed properly, they allow for premium collection in a safe, fully hedged manner. All of these strategies are cost efficient, and the vertical spread will actually allow for directional gain as well.

Right or wrong, successful or not, buy and hold is a strategy of the past. Income generation through premium collection IS the wave of the future, and I for one am willing to bet that it will prove to be much more successful than its predecessor!

If you are interested in more information on premium collection or premium collection services from Ron Ianieri, click here.


Article printed from InvestorPlace Media, http://investorplace.com/2010/08/premium-collection-selling-options-to-generate-income/.

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