Two Option Strategies for Value Investors

I use fairly strict conditions to put these trades on. The market has to be down, and volatility needs to be high. In a perfect world, I like to see the VIX [CBOE Volatility Index] about two standard deviations above its 20-day average. At such times I can be reasonably sure that the options I am selling are somewhat overpriced and that I am not buying Cubs tickets for an options trader somewhere in Chicago.

I have to like the stock and be very comfortable, if not ecstatic, at getting put the stock at the strike price minus the premium. I only sell out-of-the-money options and never overwrite or sell in-the-money options, hoping the stock rises above the strike in the holding period.

I also sell short-dated options. If I were putting on a trade today, I would only use May and June options. Any longer invites too much uncertainty in my mind. I really like using this strategy with some of the stock screens I have developed over the years that reveal stocks that deliver most of their outperformance in the later portion of the holding period.

I talked about one such screen not long ago. The Value Line top-ranked stocks with the highest projected appreciation and low debt-to-capital ratios deliver most of their outperformance in the last year of the holding period. This makes them perfect candidates for selling short-dated puts in the first year, to collect premium and gain incremental return.

Right now, the market is too high and volatility is too low, but if stocks that make the list, such as Calloway Golf(ELY - Cramer's Take - Stockpickr) or Staples(SPLS - Cramer's Take - Stockpickr), were to decline, and if the VIX increased, I would consider selling puts.

Playing the Combo

The other trade I really like to use is the combination trade. This means simply buying the stock and selling a put below the market and a call above the market. Unlike selling puts here, I want to be selling long-dated options to collect as much premium as possible. I use this trade when three conditions are met:

1. I like the stock and am comfortable with a partial position at the current price.
2. I am willing to buy more at the lower strike minus the premium collected.
3. I would be happy to sell at the higher strike plus the premium collected.