by Lawrence Meyers | July 17, 2014 11:00 am
Every week, I write an article suggesting various strategies for options trading. In my 18 years as an investor, I came to regard trading options as an income-producing strategy. By selling covered calls against long positions I held that were stagnating, I could juice them for 2% – 2.5% premium each month
Then I realized I could sell naked puts against stocks I wouldn’t mind owning, which freed up my capital for other things unless the stock got put to me. I’ve been lucky thus far — by sticking to options trading with stocks I know very well, and whose patterns I have recognized, more than 70% of my personal options trading strategies go unassigned.
Trading options, however, is most often associated as a hedging strategy. In some cases, the option trading strategies are used for stocks you own. However, are there times when option trading strategies make sense in lieu of actually owning or shorting individual stocks?
You bet there are.
With the explosion in ETFs, investors can now focus their trades on individual sectors, different asset classes, different countries, and even technical indicators. For those with good instincts, options can be a way to profit without exposing oneself to the risk associated with actually owning the security.
For example, I’m concerned about the retail sector after an abysmal Q1. The SPDR S&P Retail ETF (XRT) is a broadly diversified consumer retail sector ETF that has everything from CarMax (KMX) to PetSmart (PETM). If Q2 retail numbers come in weak over the next month, the entire sector could get taken down. The ETF currently trades just below $85. The August 85 Put is very cheap, and you can buy it for $1.71.
So if the ETF breaks down under $83.29, you’ll begin to profit. What I like about this trade is that if I had chosen to short the ETF (or go long in other cases), I would normally set a 7% stop loss, generally considered a standard stop-loss threshold. With a put, I’m spending less than 2% of the price of the ETF, and my risk is limited with whatever I pay for the put.
I think hard assets are going to surge again, because economic confidence is going to wane. Now, I hate trading gold. I’ve done well trading oil, but gold continually makes me whiff. I believe gold should be a part of everyone’s long-term portfolio, but given the present state of things, and gold’s volatility, I would prefer to limit my risk using options trading the SPDR Gold Shares (GLD).
GLD presently trades at 10% of the price of gold, or $125.42. I might buy the March 2015 $130 Calls for $3.70. In this case, I am exposing myself to risk that represents less than 3% of the value of the ETF, so again I’m coming in under the 7% stop-loss (which, believe me, has been triggered more times than I can count with gold). I’m also giving gold eight months to move past the $1,300 mark, which I think is very likely.
These are just a couple of quick examples of how options can help you rake in profits without exposing yourself to high levels of risk. The next time you’re thinking about shorting a security, ask yourself if options aren’t a better way to profit from the opportunity.
As of this writing, Lawrence Meyers did not hold a position in any of the aforementioned securities. He is president of PDL Broker, Inc., which brokers financing, strategic investments and distressed asset purchases between private equity firms and businesses. He also has written two books and blogs about public policy, journalistic integrity, popular culture, and world affairs. Contact him at email@example.com and follow his tweets at @ichabodscranium.
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