The prevailing wisdom is that the way to make big money in options is to sell covered calls against high-priced stocks. It’s true that you can potentially make a couple thousand dollars in one fell swoop via that strategy. However, there’s another way to play the game that involves super-cheap stocks, which allows you to buy or sell options in bulk. Not only does this method save on commissions, but it can give you flexibility when dealing with the underlying stock.
Bank of America (NYSE:BAC) is a great example. It’s hard to say where the company is going from here, and buying or shorting the stock itself is a tough call. One plan I like is to purchase 1,000 shares of the stock at $7.71 then sell 10 April-dated, 8-strike call contracts for 33 cents each, for a total credit of $330 (33 cents times 100 times 10).
You can also sell 10 of the April 8-strike puts for 60 cents – a total of $600 for the 10 contracts. So first off, you end up collecting $930, or about 93 cents per contract. If the stock goes above $8 at expiration, you’ve just collected that $930 along with another $290 in capital gains as the stock moves from $7.71 to $8.00 (or beyond). That’s a total return of $1,120, or 14.5%. If another 1,000 shares gets put to you at $8, you now have 2,000 shares of the underlying at a net effective buy-in price of $6.92. Barring some disaster between now and April expiration, you’ll be able to turn around and do the same thing at either the $7 or $8 strike price.
Sirius XM Radio, Inc. (Nasdaq: SIRI) has really been a day trader’s dream. That means it’s also ripe for option plays. As it happens, I think the stock will do well over the long term. This is a great opportunity to sell the heck out of naked puts.
In this case, I’d push way out to September because the premiums are comparatively small, but I’d sell a bunch of September 2.5-strike puts for 40 cents per contract. That’s a 17% return on each put, and if you get the stock put to you, you’re protected down to $2.10. If that happens, you can then sell the January 2-strike calls come September expiration.
LSI Corporation (NYSE:LSI) is a play I like even better. This is the perfect, cash-heavy-no-debt tech stock to play with options. It has solid free cash flow and isn’t going out of business by any means. With the stock at $8.08, I’d again load up on 1,000 shares, then sell 10 April 8 calls for 35 cents, as well as 10 April 8 puts for 35 cents each. So you end up collecting $700 – $350 from the calls and $350 from the puts.
If the stock is trading at $8 or higher when the options expire, you’ve just collected that $700 less $80 in capital losses, for a total return of $620, or 7.9%. If another 1,000 shares gets put to you at $8, you now have 2,000 shares of the underlying at a net effective buy-in price of $7.38. Barring a disaster between now and April expiration, you’ll be able do the same thing in a few weeks at either the $7 or $8 strike price.
Biotech firms can also be good option plays, but remember you want to stay away from those that are about to make some big report on a drug trial. Take a peek at Neurocrine Biosciences (Nasdaq: NBIX). Here you can just sell the April 7 puts naked for about 40 cents per contract. That right there is a 6% return, and the strike is 5% away from even having the stock put to you.
As of this writing, Lawrence Meyers did not hold a position in any of the aforementioned securities. He is president of PDL Capital, Inc., which brokers secure high-yield investments to the general public and private equity. You can read his stock market commentary at SeekingAlpha.com. He also has written two books and blogs about public policy, journalistic integrity, popular culture and world affairs.