By Alex Gavrish, Etalon Investment Research; author of "Wall Street Back To Basics"
Conservative strategy for uncertain market conditions
During periods of uncertainty in markets many investors find it hard to initiate new long positions. Some experts perceive the market currently as overvalued and preach caution and restraint. Focusing on fundamentals and timeless value-investing principles will serve investors well during such periods. Combining value and a fundamental valuation approach with a conservative options strategy can provide additional downside protection while generating attractive income.
The approach involves selling insurance policies put options against the decline of individual equities. By selling such an insurance policy you agree to buy the stock of a specific company at a certain price during some period of time, which can be anywhere between a month to one year or even longer. In return for agreeing to do so, you receive a premium, just like an insurance company. In case the stock price declines below the price at which you have agreed to purchase it, you will have to purchase and own the stock.
Strategy performanceBoth academic and business literature have proven that the approach of selling put options achieves better results than market averages over long periods of time with a volatility that is significantly lower than that of the market. The Chicago Board of Options Exchange CBOE has developed a Put Write S&P 500 Index, which measures the performance of a strategy wherein one sells an at-the-money put option with a maturity of one month on the S&P 500 Index SPY, and continues to do this consistently each month. This strategy has outperformed both S&P 500 INDEXSP:.INX Index as well as Buy Write S&P 500 Index a strategy of selling covered call options.
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