The following commentary comes from an independent investor.As an investor who prefers to use options to make long-term, instead of speculative, trades, I often cringe when I read articles touting strangles, straddles, other more complicated spreads and, worse yet, directional bets on volatile stocks.
Covered Calls and Cash-Secured PutsAlthough roughly 75% of my portfolio tends toward a buy-and-hold philosophy, often in dividend-paying stocks, I think most portfolios can and should make room for speculation and active trading strategies. An excellent way to work active trading into a long-term investment plan involves moving between covered calls and cash-secured puts, though not necessarily in that order. Earnings season can represent an excellent time to sell options because implied volatility often sends premiums higher ahead of a major event. Let's consider an example. When using the following strategy, you must come to terms with yourself on several important qualifiers before executing the trade:
- If you write a covered call, you must be content with the point at which you cap your potential profits.
- If you write a covered call, you must be all right with the possibility that the stock drops below your break-even point on the trade, which would result in on-paper losses.
- If you write a cash-secured put, you must be OK with the chance that the market price of the underlying stock drops below -- maybe even well below -- the strike price of the put you sold.