Good Evening, Friends; here’s hoping that everyone is thriving. Like many people here, I spend the bulk of my day trading the E-mini futures utilizing the training that I received some years ago from Todd. In addition, I typically have some positions in stocks, and I trade options. Recently, again like a fair number of the people to whom I speak, I’ve been nervous about the fundamentals. Not Syria, so much, but the reaction of investors to the actual onset of Fed tapering (which could occur as early as September 18) does have me concerned. In addition, we have Federal budget and debt limit negotiations about to take over the front pages, and I doubt that there will be much there to make investors more bullish.
At the same time, Todd teaches us, quite correctly, to focus on price, since that’s the distillation of what everyone thinks they know about the future. I may sometimes think that the market has it wrong, but that normally means that I’m missing something, and in any case, the market has way more money than I do. Still, given my concerns, it’s sometimes hard to buy stocks, even though the price action is positive. In particular, I hate the feeling of reaching, of knowing that I could have purchased a stock at a lower price yesterday, while of course simultaneously fearing that it could be higher tomorrow.Â
I’ve learned to deal with that in a couple of ways. One is to start with a small position, adding to it on pullbacks and purchasing more when it dips after moving higher, using Fibo levels and other techniques taught by Todd. Another approach that I recently used to purchase QCOM is to sell options to reduce the net purchase price. On this occasion, my initial purchase was at 67.03, close to the high of the day, on August 14. I also sold a September 67.50 call and a September 65 put. That is, I went long stock and short a strangle, which is called a “covered combo”. The premium on the options was 2.23, reducing my cash outlay to 64.80.
Since I was short a 67.5 call, the most I could earn on the stock was an additional 0.47, but since I had already taken in 2.23 in premiums, that made my total cash flow if called away 2.70 on a cash outlay of 64.80, or 4.17%, not bad for a month’s “work”, even after commissions. I also had a cushion in case I was paying too much for the stock; since my breakeven was 64.8, the stock could drop by 3.3% before I started to take a loss. If put, I would own twice as many shares, and my cost basis would be 64.90 (64.8 + 65/2). I liked the outlook for the stock, and the ability to weather some adversity gave me the confidence to pick up a reasonable number of shares, relative to my account size.
Despite my fears, the stock went on to behave well, never dipping below 65.74. In the past few days, it has run up nicely, and today I went ahead and covered the initial short options – taking a 0.26 loss in the process because of the appreciation in the short call – and then sold a Nov 70 call and a Nov 65 put for a total premium of 3.77. The loss on the original options brought my cost basis back to 65.06, but the stock at the time was at 69.54, a gain of 2.51. In addition, I had now added 3.77 to my account, reducing my cost basis to 61.29, 11.86% below the stock’s price at the time. QCOM actually closed above 70, but I can always buy back the short call on a dip, and if there is a prolonged period of weakness in the market, or in the stock, I have the room to adjust the position as needed, retaining the bulk of my profits.Â
Things don’t always work out this well, but had I not been able to employ this option strategy in all likelihood I wouldn’t have taken the trade at all. I could have made considerably more money by just buying Sep 67.50 calls, as it turns out, but since I was short puts as well as calls, the combined premiums earned produced a very nice annualized gain. Besides, I wouldn’t have done a straight call buy, making the possible gains moot. If called at 70 in November, I’ll have made 8.71 on cash outflows of 61.29 over 93 days. The return is 14.2% for the holding period, or 55.8% annualized. Commissions reduce that somewhat, but it’s still the sort of return that I hope to routinely produce on an annual basis.Â
In any case, that’s just one trade, but it’s an approach that you may wish to consider if you are concerned about levels, but feel that stocks are moving higher without you, and want to gain some exposure. Two things to consider; first, the stock needs to be one that you would conceivably wish to own more of at a lower level, since you will be short puts. You will need to have sufficient margin set aside to pay for that stock while you are short the puts. Secondly, a stock with a decent dividend is liable to be called away if you are short calls into the ex-dividend date, so it is necessary to keep an eye on those, and in particular avoid calls that expire close to an ex-date. I’d suggest paper trading a couple of these, just to get a sense of how things work in practice.
Whatever you decide, best of luck!
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