THE STRIKING PRICE
Monetizing the Fear of Others
By STEVEN M. SEARS - Barrons
Selling puts in order to buy stocks at good prices is expected to be a key options-market theme this year.
IF YOU LIKE BUYING STOCKS smartly, you’ll love selling puts.
The strategy lets investors buy stocks at below market prices, which will increase investment returns if stocks behave as expected.
In 2010, many traders anticipate that stock prices will advance in response to spreading financial stability, and a resumption of economic growth, which supports the use of options strategies, such as selling puts, that do not limit potential gains.
Many investors and traders feel the risk in 2010 is not missing additional stock rallies, whereas the risk in 2009 was hedging against systemic risks and the collapse of major companies and economies.
Investors who share this bullish view common amongst many options traders can take advantage of remaining investor angst that is responsible for robust put prices.
In essence, selling puts lets investors leverage the residual fear that many big investors feel about another stock decline.
When investors are afraid that stock prices will decline, they buy defensive put options. Put options increase in value when stock prices decline. Conversely, call options increase in value when stock prices advance.
In 2009, selling calls and buying puts — either in tandem or individually — was a key strategy theme in the options market. In 2010, selling puts and buying calls will likely emerge as key themes.
Anyone who sells puts effectively takes advantage of the residual concern amongst many major stock investors that stock prices could decline if the sleeping hobgoblins of the economic recovery, including inflation, reassert themselves. This concern is prompting many investors to continually buy puts on stock indexes and individual shares.
This fear among major investors creates opportunities for nimble investors to sell out-of-the-money puts that expire in one to three months on stocks that they would like to own.
Say an investor would like to own Apple (AAPL). With the stock around $212, investors could sell February $210 puts that recently traded at $10. If the stock declined below the options $210 strike price, they must buy the stock, though the purchase price is offset by the $10 received from selling the put. If the stock price continues to advance, the put seller can pocket the $10 for selling the put.
Melding trading strategies with stock investments always seems easy when described in columns or investment strategy pieces. But when money is poured into the ideas, the situation can get complicated fast if market conditions change. Anyone who uses options to more cost-effectively buy stocks, or to leverage returns, will be well served by regularly monitoring positions.
The 2010 market outlook seems bright and bullish, but one of the key lessons of 2009 is that it pays to be paranoid.