Traders don't often pay attention to stock holdings that have gone dormant. However, with the proper implementation of selected options strategies, these stocks can offer significant income opportunities. Let's review these strategies and how to deploy them.
Basic Covered Calls
First, you can use a basic covered-call strategy. This is where you own the underlying stock and write calls against it, generating premium income. You'd do this if you are neutral and don't expect much movement in the short run. Typically, you'd sell a slightly out-of-the-money short-term call on these types of stocks. The major advantage to this strategy is that the premium received for the sale of the call option can increase the rate of return by providing income. Also, the stock's downside risk can be reduced, as the premium collected for the sale of the call option reduces the cost basis of the stock, giving you a protective buffer for some downside movement. The tradeoff is that regardless of how high the underlying stock rises, the profit is limited to the income received for the sale of the call option. The risk in this strategy develops if the underlying stock declines by more than the amount of the option received. At this point, the premium no longer protects you against losses, and so you incur further risk if the stock continues to decline past the break-even price.
Butterfly and Condor Spreads
Some slightly more complex strategies to consider are the short butterfly and short condor spreads. The short butterfly spread entails being short a straddle and long a farther-out-of-the-money call and a farther-out-of-the-money put. Look at it also as a bear call spread and a bull put spread, where the short call and short put have the same strike price. This spread results in a net credit to your account. The short condor spread is when you're short a strangle and long a farther-out-of-the-money call and a farther-out-of-the-money put. It too can be explained as a bear call spread and a bull put spread, but the short call and short put have different strike prices. This spread also results in a net credit to your account. These strategies enable you to earn profits from time decay, while taking advantage of the small magnitude of market movement, regardless of market direction, while limiting the amount you can lose (in the case of the butterfly and condor) and lowering the stock's break-even (in the case of the covered call). When employing short butterfly and short condor spreads, look for stocks that you feel will behave in a stable manner over the short term. Check to see that no major news events are pending that may cause the stock to move significantly; in that case, you could lose money. To realize your full profit potential from time decay, you have to stay in the trade through expiration -- therefore, the shorter the timeframe, the better. The wider the spread between the middle strike and either of the wings, the wider the profit window will be. The tradeoff is that you're assuming greater risk. Also, given the multiple legs of these butterfly and condor spreads, you must keep a close eye on commission charges. In conclusion, the covered call, short butterfly and short condor are good cash-flow strategies for stagnant equities. These should be part of your trading arsenal when dealing with quiet stocks. Happy trading.