Options for Getting Close to the Goal - TheStreet

Investors are often warned against engaging in a market-timing investment strategy, usually by the same folks who issue buy high/sell low recommendations as they try to keep pace with their benchmarks.

We don't need benchmarks. We look at absolute return. Losing less money relative to the performance of an average is minimal consolation. Enter options. With options, like horseshoes, being close counts.

Buy Low, Sell High

Last Monday's close of 845 on the

S&P 500

left the index within striking distance (about 8%) of the October lows. Let's not overanalyze anything, but consider the one-year chart below. It shows good support at 800 and seems like an obvious place to start buying stocks.

Near Support Levels
The S&P is close to a zone buyers might like

Source: BigCharts

And a look at the one-year chart of the CBOE Volatility Index, or VIX, shows now isn't a bad time to start selling options.

Producing Income
Here's a place where selling options can work

Source: BigCharts

Selling naked puts is a dangerous proposition in that it exposes you to substantial risk. While the maximum risk is only marginally different than going long the underlying contract, the reward is limited to the premium sold.

Here's a quick example. Suppose XYZ shares are trading at $50. The March XYZ $50 put is trading at $2. The table below compares the profit/loss profile of buying 100 shares of XYZ at $50 vs. selling one March $50 put at $2 at various prices come March expiration.

Obviously, the risk/reward in absolute terms may not seem too attractive. But this strategy is a wonderful way to take in premium income and/or to establish a level at which you'd be happy being long the underlying asset. Remember, if a put is in the money at expiration, you will probably be assigned and therefore long the underlying security.

In the example above, if XYZ settled at $48 on the March 15 expiration, the put-seller would be assigned and now be long 100 XYZ shares. The cost basis would be the strike price ($50) minus the put premium ($200) sold, or $48. So far the put-seller is breaking even. If one had simply been long the stock, a paper loss of $200 would be marked.

Now let's apply this to the S&P. As of the close on Monday, with the S&P at 860, you could sell the March 825 put for $23. That gives you a break-even of cost basis of 802, a 6.7% drop from current levels. One extra feature is that the current prices reflect a relatively high implied volatility of 32.4. This provides an extra cushion, in that even if the S&P declines over the next month, implied volatility contracts the put-option price.

If the S&P closes above 825 on the March 15 expiration, the maximum profit of $2,300 per put contract will be realized. But keep in mind that if the index continues to drift lower, the position can be closed out at any time prior. And as the table above shows, you may still reap a profit.

Steven Smith writes regularly for TheStreet.com. In keeping with TSC's editorial policy, he doesn't own or short individual stocks. He also doesn't invest in hedge funds or other private investment partnerships. He was a seatholding member of the Chicago Board of Trade (CBOT) and the Chicago Board Options Exchange (CBOE) from May 1989 to August 1995. During that six-year period, he traded multiple markets for his own personal account and acted as an executing broker for third-party accounts. He invites you to send your feedback to

Steve Smith.