Why Serious Investors Should Look at Option Strategies

First, what Options are not: Options are not a form of betting. Options are not about trading on a computer program purchased for $10,000. Options are not about investing all your capital in each trade. Anyone who approaches options with this attitude will lose their shirt.

Serious and professional investors use options as a form of insurance, and to provide extra income for their portfolio.

Why should you start to think about options? I believe the market is cheap at present. And I fully expect to see the market move back towards 6300 over the coming 12 months. Second, I believe that the market will trade sideways from 6300 for a number of years after that. Keep in mind that even when the market moves sideways there will still be spikes and dips.

Below I will discuss two simple strategies. The first is an actual strategy I did last week. The second is a strategy you could use right now. Both have very different reasons as to why you would do them.

Sell a Call
You would look to use this strategy if you think that the price of a stock you hold (in this case BHP) has topped and is likely to fall. However, you do not wish to sell due to the capital gains tax issues.

In my example I sold a $42 call, this means that I have given someone the right to buy 1000 of my BHP shares at $42 and for this they have paid me $2,350.00. At the time I sold this call, the price of BHP was $42. As such, if I have to sell my 1000 shares I will receive $42,000 plus the $2350, giving me a total of $44.35 per share. Overall, I would be happy with that price.

One of two things can happen.
1. The price of BHP continues to move up and I end up selling my shares for $44.35 and lose any upside beyond this.
2. The price of BHP moves down, this is in fact what happened. BHP moved back to $37.00 per share. Therefore, my shares that were worth $42,000 are now worth $37,000 a loss of $5000.00. However, I also made $2350 from the sale of the call reducing my loss to $2650.

Overall, a good result. Keep in mind that I have a low cost base on the share and had I sold the shares on market at $42 and then purchased them back at $37 although I would have saved $5000, but it would have cost me more than this in capital gains tax and transaction fees.

Selling a call is used to protect your portfolio from any downside movements
in the price of your share and improve the income of your portfolio.

Sell a Put
You would look to use this strategy if you think that the price of a stock is cheap right now and you would be happy to buy at the current price but would like to try to get it a little cheaper.

Let us look at a live example, which you could have done last Friday.

I would look to sell a $10.65 Put over Suncorp. This means that I have given someone the right to sell my 1000 shares in Suncorp at $10.65 per share, and for this they have paid me 0.44c per share. At the time I sold this Put the price of Suncorp was $10.70 per share. If I have to buy the 1000 shares in Suncorp it will cost me $10,650, less the $440 I was paid when I sold the Put. This brings the overall price of the Suncorp shares down to $10.21 per share ($10.65 less 0.44c). Overall, I would be happy to buy 1000 shares at the current price of $10.70 so I would be more than happy buying them at $10.21.

One of two things can happen.
1. The price of Suncorp continues to go down and I end up buying the shares for $10.65. Keep in mind that I have already been paid the 0.44 cents, so my actual cost was $10.21. The risk with this strategy is that Suncorp goes broke and the shares are worthless. This is why we only do this strategy over a stock, which is very unlikely to go broke, such as Suncorp.
2. The price of Suncorp moves up. In this case, we do not buy the shares in Suncorp and as such, we miss any upside in the share price. However, for our troubles we end up with $440 in our pocket.

As you can see in both of these strategies you could miss out on future upside in the shares price, but please keep in mind that we are employing this strategy at a time when the market will be moving sideways. There will be other opportunities to get into the stock later.

Do these strategies interest you?

Give us a call and we can discuss it further. Ph: 07 4771 4577.

PS. Please be aware Options are not for everyone. We do put you through a screening process before we will advise or perform any trades on your behalf.