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Concerned about a decline in the market?

Try these option strategies to hedge your portfolio.

Modern Portfolio Theory tells us that the main driver of long-term returns is asset allocation, the mix between risky and risk-free assets.  Its purpose is to achieve the highest possible expected return with the lowest possible risk.

Asset allocation is foundational to risk management.  Nearly 94% of a portfolio’s return is attributable to its asset mix*.  Everything else – portfolio construction, security selection, periodic rebalancing – is peripheral.  Still, option hedging strategies can provide short-term relief from temporary volatility.

The market continues to trade near record highs, and for the time being, volatility has remained relatively tame.  If you are concerned that these two scenarios might change, then there are several options strategies you can employ to hedge against a market decline or a rise in volatility.


(Source: StockCharts.com)

The approach you take will depend on your trading experience and sophistication, the approval level your broker has assigned your account, and whether or not you’re looking to create premium income.

There are two very straight forward techniques that can give you a short-term hedge.  They are a long put spread and a short call spread. Let’s review those first. Afterward, we’ll look at a couple more sophisticated structures.

The Long Put Spread

A long put spread is a straightforward debit spread (you’re paying premium) intended to profit if the price of the underlying security declines in value.  For this example, let’s use the proxy for the S&P 500, the SPDR S&P 500 ETF Trust (Symbol: SPY).

As I write this, SPY is trading at right around 320.  Let’s assume that you think the market could suffer a 2% decline in the next few weeks.  That would take it to about 314.

There’s some support at 316, so let’s use that as our short strike.  If we use today’s price of SPY as our long strike (320), then we’ve got a four-dollar spread that will cost us about $1.17.  That gives us a pretty decent risk to reward on the trade.


Here’s what this trade looks like come expiration week.

We lose the whole $1.17 if SPY is above 318.82 (that’s our breakeven) at expiration.  Anything below that and the trade is profitable.

The attractiveness of buying a spread instead of being long just the (higher, more expensive) at-the-money strike is that the sale of the lower strike option offsets the total price of the position.  You lower your risk because you pay less to accomplish the same hedge. Now let’s look at creating this hedge using calls.

Short Call Spread

A short call spread accomplishes the same objective as a long put spread.  It will become more profitable as the underlying declines in value.

We’re going to use the same fact pattern on this trade.  We’re still going to buy the higher strike and sell the lower one (long the 320, short the 316).  Of course, the really important difference in this scenario is that we’re using calls, not puts. Using the options montage above, we see that we’ll collect $2.82 in premium to open this position.

The risk to reward is the same on this trade as it is on the long put spread.  The breakeven price is the same. So is the profit probability. The performance graph looks the same as well.  There are two differences between these two trades (other than the type of options being used).

The first is that you’d be paying premium for the put spread, and you’d be receiving premium on the call spread.  The long put spread wouldn’t have an impact on your account’s equity position (margin). The short call spread, however would.  You’d tie up $400 of margin for each contract you sold.(This will vary by the margin requirements of your broker) So if things didn’t go as planned and if you didn’t manage your other trade positions carefully, then you could find yourself with a margin call.  So you want to be careful with any credit spread.

Hedging in General

As the two examples above illustrate, hedging against a decline in the market can be accomplished using either puts or calls.  We used the SPDR S&P 500 ETF Trust (SPY) to illustrate this. But market hedges can be affected using any index ETFs, including:

  • QQQ – NASDAQ 100
  • IWM – Russell 2000
  • DIA – Dow Jones Industrials

Each of these ETFs have listed options.  The effectiveness of any one of them as a hedge would depend on the makeup of an investor’s specific holdings.  This is known as basis risk. Someone with a large concentration of tech stocks might use QQQ. Someone with exposure to mega cap stocks might use SPY or DIA.

There is an ETF for just about every industrial sector in the economy.  Most of them have listed options that can be used for hedging purposes. And, of course, there are listed options on thousands of individual stocks that can help one create a stock-specific hedge.  For investors looking to hedge market volatility, there are options on the VIX index.

To hedge an increase in market volatility, one could buy a call on the VIX or sell a put spread.  The VIX index rises as volatility increases, which normally means the market is declining. 

Two Sophisticated Hedges

Investors with greater experience trading options might also consider two other strategies to hedge a market decline or an increase in volatility.  The first approach is only appropriate for an investor with exposure to a given stock or index ETF. The strategy is known as a collar.

A collar is structured by selling an out-of-the-money call and using the proceeds to purchase an out-of-the-money put.  The trade limits the investor’s profit potential on the underlying’s appreciation beyond the short call. But the long put prevents the investor from suffering a catastrophic loss if the underlying has a precipitous decline.

The reason this structure should only be initiated by someone who is very experienced trading options and who is long the underlying security is that the short call in the collar is naked.  Unless the option writer owns the underlying, he or she is exposed to unlimited risk. And the long put does not offset that risk.

But for the investor who has enjoyed acceptable appreciation in the underlying, and is willing to reduce some or all of the holding risk if the short call is assigned, then a collar presents a very reasonable hedge.  In some cases, the proceeds from the short call can completely cover the cost of the put. When this is the case, then the investor has effectively created a risk-free hedge if the price of the underlying remains within the two different strikes.

Here’s what the risk/reward profile looks like on a covered collar.

Those with experience will notice that the profit and loss profile of a collar is very similar to that of a covered call.  The only difference is that the collar limits downside risk to the strike of the put. A covered call has the same downside risk of owning the underlying.

To hedge an increase in volatility, long exposure to the VIX index is the most straightforward strategy.  As noted above, one can gain that exposure by owning a VIX call option or a long call spread. An investor can create a synthetic long position by writing a VIX put spread or by entering into a risk reversal.

A risk reversal is created by buying an at-the-money call and selling an at-the-money put.  From a risk/reward perspective, a risk reversal behaves (at least until expiration) exactly the way a long position in an underlying security behaves.  It’s like buying the underlying outright, except that it costs less and ultimately expires.

Many times, the proceeds from sale of the put to completely offset the cost of buying the call. Volatility skew is the reason for this. Most option users are using them for hedges; therefore, implied volatility in the puts is generally more expensive than the calls.   Therefore, you can create a hedge at no upfront cost, and if there is a cost its generally minimal and requires less capital than buying the underlying outright.

With the market trading near record highs and relatively free from volatility, the strategies noted above could provide protection – and peace of mind – if things suddenly reverse direction.

USING OPTIONS TO GENERATE INCOME IN RETIREMENT

For many investors, dividends provide the primary avenue for generating income. While this typically proves effective, there are other ways to get the job done, particularly if you’re an active investor who prefers daily interaction with his or her portfolio. After all, for many of us, that’s part of the fun of investing — spending time, strategizing, and doing everything you can do to achieve your goals.

In this article, we consider how you can utilize options to generate income as you approach or enter retirement. A covered call strategy won’t work for everyone. First and foremost, there are real tax considerations. For some, taxes will be a major concern. For others, not so much.

Many long-term investors have a portfolio of stocks. Again, this can work in isolation, particularly if you’re collecting or reinvesting dividends.

However, if you’re willing to take on a touch of measured risk, you might be able to increase income while you learn a new way to manage your money. In a perfect world, with a large enough portfolio, you might be able to live off of your income or, at least, supplement other sources.

Sample Portfolio

Consider a hypothetical portfolio of five stocks. To make things work from an instructional standpoint, we’ll use round numbers. Alongside each stock, we’ll concisely detail the option strategy we’re using. Below the table, we’ll get into greater detail concerning what’s at play.

*All prices approximate, as of midday, Thursday, September 5, 2019.

Please note that while I pulled live quotes for both the stock and option prices, the price you receive can vary considerably on the basis of several factors. Consider everything you see here approximate numbers and for illustration purposes only.

Based on the table, you’ll produce $1,442 worth of income via covered call writing on AAPL, ALGN, T, and DIS.

When you write a covered call, you receive a premium but run the risk that you might have to sell your stock at the option’s strike price. For example, if AAPL hits $215, your shares might get called. If AAPL goes to $217, you still have to part with your shares at $215. However, the premium you collected ($1.92) helps offset that loss. And, again, your numbers will vary. What you see here depicts how the strategy can function.

The table shows how you can structure a portfolio of stock alongside income-generating covered calls. I have heard of investors writing weekly calls on AAPL consistently. Covered call writing can yield a significant amount of income. It takes time and effort. It requires strategic thinking in terms of taxes and the strike and expiration dates you select as well as how you would feel and what you would do if you had your stock called. But it can be a lucrative strategy, particularly when executed on dividend-paying based on.

In some instances, you’ll do nothing. With liquidity scarce and premiums too low to warrant effort, it simply makes no sense to try and write calls against SIRI stock. At least, not as of this writing. Some positions scream for covered call writing, others not so much.

Finally, if you take this or a similar route, you’ll want to map out your options (in the general sense of the word). Consider everything that can happen and determine your course of action, so you’re ready to move fast.

For example, if your stock gets called, what will you do? You could wait for a pullback and buy it again. You could execute a buy-write strategy right away. With a buy-write, you buy the stock and write a covered call against it at the same time. As in, buy 100 shares of a stock for $100 and write the $105 covered call, collecting a premium of, hypothetically, $2.85. Now the effective purchase price of the stock $97.15.

You get the picture. It’s a case of deciding how much time you are willing to devote to your portfolio and how complicated you want to make your income generation strategy.

Top 21 Holiday Gifts for Investors and Traders

Are you struggling with what gift to get for the trader and or investor in your life? 2019 was a volatile year of dodging Trump tweets, potential China trade deals. and failed IPO’s.  If you don’t want to buy another awful gift and want something that makes them feel like they are five years old again when they unwrap it, well, then take a look at the 2019 Christmas list with holiday gifts for investors and traders that we believe you will love. If you’re an investor that is somewhere between saving your pennies and looking for a Lamborghini well, then we have something for everyone. 

1) DJI Mavic Air Quadcopter with Remote Controller
As investors, we’re used to a series of ups and downs. The DJI Mavic Air Quadcopter is designed to smooth those bumps so you can experience the joy of flying a drone without all the spikes and trough that you’d find on a Nonfarm Payroll Friday.

2) Real Relax Massage Chair, Full Body Zero Gravity Shiatsu Recliner with Heat and Foot Rollers, Black
A vibrating chair? Sure, we’ve experienced massage chairs before, but this one’s unique. You know that feeling after you see a trade enter its take-profit position? Or when you exercise your option? The sigh of relief that you get from those situations is similar to how this chair makes you feel. It’s almost like there’s a tiny Swedish woman inside it, giving you a massage.

3) Philips Sonicare DiamondClean Smart 9750 Rechargeable Electric Toothbrush, Lunar Blue HX9954/56
When you go out for a dinner to celebrate that big score, you want to have your best pearly-white smile. As investors, we understand that you can’t shortcut greatness. This toothbrush is designed to deliver the kind of clean that has everyone at the restaurant wondering, “What does he do to his teeth?” A brilliant

4) Jura J6 Automatic Coffee Machine (Brilliant Silver) + Free Jura Chilled Milk Container, Jura Smart Filter Cart
As investors we run on two things – dreams and coffee. While you’re responsible for achieving your dreams on your own, this coffee make will take care of the other half of the equation. If your trader ends up spending a lot of their money on Starbucks coffee like I do, you’ll realize pretty quickly that this does everything those fancy baristas can do, and they don’t even need to put on pants to get their half-caf macchiato! Convenience, thy name is Jura. Hey, it even does monkey-poo coffee!

5) chiliPAD Cube 3.0 – ME and WE Zones – Cooling and Heating Mattress Pad
Traders usually have weird hours. There are three markets we have to keep track of and getting a good night’s sleep is crucial to that. If your trader finds himself rolling out of bed with poor rest, then their trades will suffer (as well as anyone else who gets in their way – bad sleep makes us grumpy). This mattress pad makes it easier to adjust the bed temperature to suit our needs, making it easier to get to sleep. Now if only my broker could do the same for my dividend stock…

6) Rawlings Rugged Briefcase, Cognac
As traders, we enjoy hitting it out of the park. Our briefcases get their share of abuse, so why not combine our great loves of baseball and beating up our hand luggage into a single, amazing brief? Made out of old baseball gloves, the texture is something that reminds you of the days on the mound when you were a kid. If your trader is a baseball fan, this is well worth it as a gift. Maybe even throw in a brand new baseball in the bag for good measure.

7) Chicago Gaming Arcade Legends 3 with Golden Tee and Installed Game Pack 536 Upgrade
Traders live for games. Some of us love the golf course, but that’s only because we don’t have the joy of a retro cabinet in our lounge. I guarantee, if your trader’s a fan of old arcade cabinets, then this one is more than worth it to get them as a present. With 165 games pre-installed, your biggest problem will be to get them to turn it off and come to dinner. But on the bright side, at least you know where they are!

8) iRestore Laser Hair Growth System
Hair is a touchy subject for us as we get older. Traders put a lot of stock into their looks (no, not that kind of stock), so having a full head of hair goes a long way to making us feel happy. And this thing really works! No, it is not the Devo hat. I swear I’m telling you the truth. I’m not saying after using this I’m these guys celebrity but I’m no Kojak either. Again, I know this looks ridiculous but if you use it truly works. Youtube it if you don’t believe me.

9) Drinique ELT-RK-CLR-24 Elite Rocks Unbreakable Tritan Whiskey Glasses
Whiskey? Gin? Vodka? Orange Juice? Whatever we drink as we watch the markets do their dance on your screen, we do so in style. If the trader in your life is like me and enjoys a little glass of something sharp while they do their thing, the Drinque unbreakable is one of the classiest (and indestructible) ways to have a taste of luxury. Fancy alcohol or orange juice sold separately.

10) Oculus VR Headset
In the 90s there was a slogan that went, “It’s the next best
thing to being there.” Oculus Rift decided to turn that up a notch and…well…actually put you there. This virtual reality headset allows for complete immersion in whatever you do. For a trader, it means being able to experience things firsthand without having to rush back and forth and deal with traffic. There is also another benefit to these glasses that I’ll leave unnamed. Let’s just say Blade Runner wasn’t far off.

11) Orion SkyQuest XT8 Plus Dobsonian Reflector Telescope
Just because we spend hours poring over facts, figures, and charts doesn’t mean we don’t look up every once in a while. If the trader in your life likes to stargaze and has a penchant for the heavens, then this telescope offers a unique viewing experience. It doesn’t matter whether they want to look at the moon, Jupiter, or their quarterly earnings reports, this telescope will allow them to get a better view.

12) simplehuman Sensor Lighted Makeup Vanity Mirror, 8″ Round with Touch-Control Brightness, 5X Magnification, Brushed Stainless Steel, Rechargeable and Cordless
They say that one’s profession is a reflection of themselves, and we traders love seeing perfection. This mirror is a perfect gift for someone who spends a lot of time taking care of their looks. If the trader in your life is a woman, or your husband should spend more time looking at his appearance, this is a great gift idea. Also, be careful of the zoom, it shows up ALL the blemishes.

13) STEM subscription Box for Kids 
As traders, we see tour future in the eyes of our kids. What do we want them to be? To know?  This STEM subscription kit sets them on the path to asking the right questions. Now, it’s unlikely that they’ll be able to build a fully-functioning rocket ship in the back yard, but at the very least, they’ll enjoy making fizzy volcanoes and understanding how the physical world works. It’s better than trying to blow up the neighbor’s cat at least.

14) Meural Canvas – Smart Digital Frame | Leonora Black | 27 inch HD Display with WiFi Powered by NETGEAR (MC227BL
Have you ever wanted to show off some of the pieces of art that really stir you, but don’t want to spend excess money on the glass frames? Or maybe you have a wife or girlfriend who LOVS changing your interior décor every week because it gets ‘boring.’ If either of these is you, then maybe getting a smart digital frame will help the problem. The Wi-Fi connection and 27-inch HD display makes it perfect for displaying anything you’d like…even the picture of the four dogs playing poker.

15) Le Creuset 16-piece Cookware Set, Cerise  & All-Clad H911SA64 Essentials Nonstick Cookware set, 10 Piece, Grey
In our downtime, we traders love to eat. Some of us cook, but others prefer to be cooked for. In either case, having the tools for the trade makes for a much better dinner or lunch. While you wouldn’t be able to get Gordon Ramsay to make an in-person appearance (your cooking isn’t THAT bad is it?) these cookware sets are ideal gifts either for the cook, or for the consumer.

16) iRobot Roomba 614 Robot Vacuum- Good for Pet Hair, Carpets, Hard Floors, Self-Charging
Maids can be a tricky subject. There’s no shortage of tropes about what happens when traders get bored and maids are home cleaning…but let’s not go there. If you want to have a home that remains clean, but don’t want a maid getting into your private areas, you should consider a Roomba. With cutting-edge technology that allows it to clean while you work, it’s silent, works well on hard floors, and won’t try to make your trader do bad things. It’s a win-win situation!

17) Powerbeats Pro – Totally Wireless Earphones
If your trader’s traveling somewhere, or just headed to the gym to work out, it’s unlikely that they want to get dragged into a discussion about the state of the economy. These totally wireless earphones are a perfect way to help them keep their focus and warn away other people who might want to make some small-talk. What’s even cooler is that there’s no wires to get tangled up anywhere!

18) Elizabeth Cotton Women’s Egyptian Cotton Pajamas
Few things feel as opulent as Egyptian cotton. If you’re a trader and have a wife or a girlfriend who enjoys luxury as much as you do, these cotton pajamas are exactly what she needs. With the way these fibers feel, you might even look forward to hugging her!

19) Dyson Supersonic Hair Dryer
I can’t be the only one who gets excited when I see the word ‘super’ in something, right? This hair dryer is designed for people on the go. So, when you’re in a rush to get that final trade in for the day before the closing bell, you need as much efficiency as you can manage. The coolest thing about it is the housing…you can’t even get burned for touching it!

20) Bradley Commercial Snow Tube for Kids and Adults
I think if you’re planning to hit the slopes for some fun this holiday season then this snow tube has the potential for a lot of fun. With UV and wear protection, this isn’t some financial bubble that will pop at the earliest sign of pressure.

21) Kid-Sized Hardwood Puppet Theater with Chalkboard
Finding a gift for kids as an investor is difficult. I mean, they can’t use a dividend growth account yet, so what do you get them? This Kid-sized puppet theatre might entertain them. The only downside is that you might be stuck watching Punch-and-Judy recreations until Easter.

We are a participant in the Amazon Services LLC Associates Program, an affiliate advertising program designed to provide a means for us to earn fees by linking to Amazon.com and affiliated sites.

Why Long-Term Investors Should Also Be Short-Term Traders

“Serious, committed, and relatively successful long-term investors tend to do best when getting involved with options.”

Using Options As a Long-Term Investor

In this article, I begin to dig into why I feel this way.

One quick note — most of this applies to trading stocks as much as it does options, though the latter is the focus here at SteadyDime.

Goals of Trading and Investing

While some of this might seem obvious, it’s necessary groundwork. Whether you invest long-term or trade on a swing and or daily basis, you do it to make money.

A long-term investor tends to build his or her portfolio for retirement or one of life’s other milestones. A short-term trader uses the money in his or her account for a wide variety of reasons, ranging from life to being able to trade bigger and more often. To accomplish all of the above, you need to make winning trades, irrespective of how long you’re holding a position.

I also argue that individuals who are big into long-term investing would love to ditch their “day job” and use the stock or options markets to make a living. I’m talking about the investor who keeps his or her portfolio open and does equity research while at work. The type who watches CNBC morning, noon, and night. The person who eats, drinks, and sleeps the market.

It’s akin to the notion that if you were ever good enough to play a professional sport, you would have forsaken everything else and played a professional sport. If many long-term investors thought it was possible to live off of whatever their portfolios produce now — without risking their long-term goals — they would probably quit their jobs and focus on the market 100% of the time. To that end, many long-term investors would probably become full-time market participants, as short-term stock or options traders, if they thought it was possible.

While most people probably could never make this dream a reality, no matter how hard they tried, I’m convinced quite a few could. It’s all about opening your mind as a long-term investor and not considering trading something somebody else does. Or something too risky for the long-term investor to get into.

Mindset

It takes just about the same mindset to be a successful stock or options trader as it does a long-term investor who stands the test of time.

First and foremost, both endeavors require unwavering discipline. They require you to research and devise a rock-solid plan and stick to it.

Like the long-term investor who will never invest in a stock that doesn’t pay dividends or only invests in stocks with P/E ratios below 50. Or must hold a stock for a minimum of one year, no matter what happens. Or some combination of these and other things. You make zero exceptions. Because, if you do, you essentially have a worthless, dog and pony show system. Sure you might have made money by jumping at an attractive “exception,” but you likely lose in the long run by being erratic or undisciplined.

To me, this stuff is trading AND investing 101. (But it always bears repeating).

If you’re a long-term investor with a system you stick to, that you see through and find success with, you are already halfway to being a not-too-shabby stock or options trader.

There’s probably nothing more important in trading than researching the indicators and such you’ll trade on, testing them repeatedly, settling on them, and then sticking to them. You’re not going to execute a trade based on your gut, a news story or what somebody said on a message board. You’re going to do it because the little line on the chart ended up where you anticipated it ending up (or whatever it is you’re going to use to make buy/sell decisions).

You have to have great money management skills. To invest long-term and keep things straight in a portfolio with multiple holdings, you have to be able to manage money or, more precisely, allocate it. I’m convinced that those skills translate to managing money as a trader. Being able to manage money well inside a long-term portfolio probably will make you better at it in your trading account. There’s a chance the long-term investor might operate a bit more conservatively as a stock or options trader, which probably isn’t a bad thing.

You have to be patient. We’re talking patience at different scales, but patience nevertheless.

Building a long-term portfolio requires you to wait through seemingly boring times. It’s not easy for many of us aggressive and impatient types to hold a stock for a couple of months, let alone a few or a dozen or thirty years. Some long-term investors plan on taking some positions with them to their graves. That level of patience makes waiting an extra second or minute or even day to pull the trigger on a trade look like nothing.

One Can Benefit the Other

Practically speaking, one form of “playing the market” can benefit the other.

Many long-term investors I know savor the days when they get their hands on extra cash. Found money or some other random lump sum means they can buy more stock. If you’re a long-term investor who also trades options short-term, there’s no better place for the proceeds of a winning trade than smack dab in the middle of your stock portfolio.

Think about it. After you do whatever you need to do with your profits from a trade (e.g., pay bills, set aside money for taxes), you can religiously invest that cash. It’s the same idea as reinvesting dividends or plowing money from a winning stock investment. You decided to close into another position. You have this pathway set up between your trading account and your portfolio. It seems like the makings of a happy marriage to me.

And, of course, as a long-term investor who doubles as or turns into a short-term stock or options trader, you can do things such as sell puts or write covered calls (and other more advanced strategies) to produce returns that can benefit both accounts.

Making the Jump

People who consider trading aren’t sure how to make the jump. They’re afraid. And for a good reason. However, if you’re one of the few who can invest and or trade stocks and options for a living, you have the opportunity to make lots of money and have a good life where you answer to nobody but yourself.

Consider the ranks of long-term investors the farm team for the world of short-term stock and options traders. More serious and thoughtful market enthusiasts should consider making the jump. The similarities and what they can achieve might surprise them.

Using Options As a Long-Term Investor

 

In the roughly two decades I have spent observing, studying, and participating in stock and option trading and investing, I have become convinced of two things:

 

  • Serious, committed, and relatively successful long-term investors tend to do best when getting involved with options.

 

  • Serious, committed, and relatively successful long-term investors absolutely should incorporate options into their long-term portfolios.

 

Some associate options with short-term, speculative trading only. Well, there’s certainly nothing wrong with short-term and (depending on how you define it) speculative trading, this stereotype often scares people away from options. We have all heard stock investors say something to the effect of I’ll never mess with options! That’s fine, but why close yourself off to the possibility of increasing your returns with very little additional risk? And what better way to introduce investors to options than with basic and, while not risk-free, relatively tame strategies.

 

In this article, I explore my favorite way to use options, logically, inside a long-term portfolio.

 

Selling Puts

 

 

Put selling is my favorite options strategy for the long-term investor. Note that when I refer to “long-term” I mean nothing less than five years, but something closer to 10, 20, or 30 years.

 

Think of a company you love- one that you would like to own for a long time at any price. In particular, this is a stock you would absolutely love to buy on a pullback. At the same time, you would also buy it for a few dollars more than your current average because, over the long-term, you think it’s going to keep going up. Not only do you desire or would you be okay with these things, but you have plans to buy more of this stock. If this describes your situation, selling puts could work as at least part of your buying strategy.

 

When you sell a put, you’re employing a bullish strategy. That’s because you’re giving yourself the right to buy a stock at a price below its current market value. You’re bullish in this context because you’re fine with buying the stock at a price lower than its current market value or you don’t think the stock will drop and simply want to bank the premium you receive for selling the put.

 

Here is an example of what I’m talking about: A stock you own presently trades for $120 a share. You are in at an average of $116.50. You want to buy several hundred shares more. You like the stock so much you would buy it at a price lower or higher than you average again and again.

 

To buy 100 of those additional several hundred shares outright will cost you $12,000. That, or dollar-cost averaging into more shares of the stock is a perfectly viable and traditional way to build a long-term position. However, selling a put to potentially get into the stock at a cheaper price adds a layer of sophistication that can reap additional rewards.

 

Let’s say you sell one August $115 put option that expires one year from now. And let’s estimate that you receive a premium of $5.50 for selling that put. You’ll collect $550 in premium on the trade. You also agree to buy 100 shares of the stock at $115 no later than next August. If the stock drops to $115, you’ll buy 100 shares at that price, less the $5.50 premium you received, bringing your actual cost per share to $109.50.

 

Of course, you’ll need the buying power necessary to execute the trade if the shares end up getting put to you. Along those lines, you’re dealing with time, in that you have tied up present/future buying power to cover the potential purchase of this stock at $115 at some point going forward. Obviously, you’ll need a pretty well-rounded portfolio with sufficient cash for this type of approach to make sense for you.

 

If the shares do not drop to $115, the option expires worthless, you keep the premium and move on. You can go ahead, if you already haven’t with other funds, and buy more of the stock at a slightly less attractive price. Because remember your mindset — $115, $120, $125 — it doesn’t matter to you. You’re going to still own this thing when you’re sixty.

 

Additional Considerations

 

 

Say you really want to make sure you get more shares of the stock at a slightly lower price than what the stock is trading at now. You don’t think or you don’t want to take the chance that the stock will go from $120 to $115. In this case, you could still invoke the same strategy, just using a put option that is closer to being in the money or is even slightly in the options.

 

For example, you could look a few months out to November of this year and with your stock trading just above $120 (say, $120.65), you could sell the November $120 put and receive, let’s call it, $3.45 in premium. This means you’ll receive $345 and have to buy 100 shares of the stock for each put you sold at $120 if the stock hits that level between now and November. But, because you took in the $3.45 premium, you would effectively be paying $116.55 per share.

 

With this strategy, you’re literally getting paid to buy a stock you would love to own at a lower price. Your main risk is that the stock will not drop that much resulting in you keeping the premium and raising the price you’ll have to pay if you still choose to buy more shares.

 

Remember, this is a stock you love so much and intend to hold for so long that a few dollars per share here or there means little to you.