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, or

Nasdaq 100

unit trust, has become immensely popular among investors, so we thought the Options Forum should take a look at the Mighty Q.

Also, some brokers won't let customers sell puts. If that's the case, should you consider another strategy?

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Q-ed Up

If I purchase 100 shares of the Nasdaq 100 unit trust, the QQQ, for, say, 180 a share, then write a covered call at the 180 strike price for the next month, are the results of an exercise the same as for a stock? For example, let's say the QQQ is trading at 200 the day of options expiration. In that case, can I expect to sell my 100 shares at 180 and be done with the trade? At current premiums (around 9 1/2), this looks almost too good to be true. If the Nasdaq flounders, I still have a good long-term investment. If the Nasdaq goes up, I still get a 5% return for just one month. -- James Albright


"Using broad strokes, yes, it's a good trade," says Chris Johnson of

Schaeffer's Investment Research

option trading and research firm in Cincinnati. Covered call-writing is a strategy in which the option trader "writes," or sells, call options while owning the underlying stock.

But watch out, the QQQ trades fast enough to give you whiplash, Johnson warns. "It's like writing covered calls on an Internet stock," he says. "Think about the companies represented in the QQQ. They are companies with higher volatility. The QQQ and its options will act the same way."

Johnson generally doesn't write covered calls with the expectation of getting exercised. Rather, he tends to buy them back. For this reason, "a lot of people write call options that are further out of the money, specifically so as not to get exercised."

The bottom line, James, is that you get less premium for writing out-of-the-money options (with strikes above the current stock price) than you would for at-the-money options (with strikes at the current stock price), but it's less likely they'll be exercised. As a result, it's less likely you'll feel silly for having to get rid of an appreciating Nasdaq position.

"There's no magical number but 10% out of the money" is Johnson's rule of thumb.

For example: If the QQQ runs up to 200, you run the chance of the options being exercised against you. Whether or not this happens depends on the market and on who bought them to begin with. Other buyers may simply sell the option back and close the position without exercising.

Now picture that QQQ running up to 200; your options get exercised and it drops to 180 in a few minutes. "So a way to avoid that is to write them further out of the money or buy them back. In some cases, the QQQ's volatility works for you, in some cases against," he says.

Johnson's outfit also does something called a "bull credit spread," which is a little more advanced. But for argument's sake, let's say the QQQ is at 1000. Johnson sells the 970 puts, collecting a premium of, say, $5 ($500 per contract). He turns around and buys the 965 put at 4 1/4 ($425), keeping the difference, 3/4 of a point spread, or "credit."

Retail investors usually can't do this trade. "This is for somebody with a nice big fat margin account and the approval to do so," he adds. "But you can do this strategy with the QQQ and using out-of-the-money options."

Short (Put) Shrift

My broker will not allow me to sell puts short even though they would be cash protected. They said I would have to use a "short put/short stock" strategy. But that sounds like a disaster if the shorted stock should escalate in price. I've called them for clarification and it just doesn't make sense. Could you help explain this strategy? -- Rich Moudy


What your broker is trying to do is give you balance in a short stock position to offset the long position you get selling puts.

What brokers worry about is clients getting caught in a huge downdraft where they end up buying into a stock before it has hit bottom. That hurts, so many brokers just don't want to do these kinds of trades.

"In many cases, writing naked puts is a bullish strategy that provides a more attractive scenario than buying stock," answers Scott Fullman, option strategist with

Swiss American Securities

in New York City.

To cut to the chase, "If you meet qualifications for writing put options and are aware of the risks associated with that strategy, you might wish to ask the firm to reconsider or open another account at a firm that permits this strategy," he says. In other words, blow the joint.

But seriously, folks, here's the thinking behind this trade and the potential outcomes:

If the stock price declines, but remains above the exercise price of the put, or the stock remains unchanged until expiration, the writer collects the premium instead of the small loss or break-even result from owning the underlying stock.

If the stock moves higher, the put-writer benefits, sometimes more than the stock purchaser.

If the stock declines below the exercise price of the put, the put-writer will own the stock at a lower price than the price at which the potential stock purchaser would have bought it. The stock buyer benefits more than the writer if the shares move substantially higher. The upside of selling a put is limited to the premium collected.

"The short put/short stock strategy is a reverse of a covered write," Fullman explains. "This strategy is bearish, with a limited price movement, since the shares would be repurchased at the exercise price." The short put/short stock strategy will not provide the same exposure or desired outcome, he adds.

For more information on this strategy, see Fullman's text

Options: A Personal Seminar


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