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. I say "worse yet" because at least when you put on a non-directional spread, you give yourself a fighting chance if you're wrong. Going long a call or a put into an earnings report often mixes a recipe for disaster. Unless I am writing a call or a put, I rarely execute options trades right in front of an earnings report, particularly on potentially volatile stocks. If I am long an option prior to a quarterly call, I make sure I go in-the-money and/or use long-dated contracts so that I have a mix of intrinsic value and time to hang my hat on if things go south. In this article, I discuss a pair of options strategies that make the most sense for long-term investors looking to collect income and possibly establish a long-term position in a stock around earnings. It's important to consider the intent of the articles I write, specifically ones that deal with options. The trades I outline will not work for all investors; instead, I hope to demystify the mechanics of relatively basic options strategies so that you can use them on stocks suitable for your portfolio at a time that's right for you.
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.