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More on Stock Option Premium Collection - Options Mastery Series Lesson 39

Filed Under Options Mastery Series 

More on Stock Option Premium Collection
 
If you insist on owning stocks in your portfolio, a covered call strategy should be an important strategy to pull out of your investor tool box when the stocks you own hit a stagnant period. Being able to capitalize on covered calls can add significantly to the overall return of the stock by adding premium collections during slow times to the gains made in times of the stock appreciation.
 
As with most stock option positions, each strategy has a sister position. As you may recall, a covered call is constructed of long stock and short calls in a one-to-one ratio. So, what is the sister of the covered call? Well, it is the opposite of the long stock-short call and is short stock and long call, normally referred to as a Synthetic Put. When you sell the call, you collect premiums. With the synthetic put, instead of writing for a premium, you pay for the put options. In other words, a covered call creates a credit to your trading account and a synthetic put creates a debit. Typically, because you are long call, the synthetic put anticipates a slight bias for a slow up trend in the stock. However, the long call is more of insurance and the real philosophy behind the synthetic put strategy is that the stock will make a rapid drop.
 
So, even though the positions between the covered call and its sister synthetic put are opposite, (long stock-short call; short stock, long call), the philosophy behind the strategies are a bit different. The covered call anticipates little stock movement, whereas the synthetic put anticipates a downward movement in the stock. Moreover, the covered call strategy is a premium collection strategy and the synthetic put is more of a directional play.
 
An important thing to remember is: the odds are in favor of the seller of an option. You see, stocks are typically range bound more than they make large moves. If this is the case, could a strategy of continuous premium collection-month after month- be an effective strategy? Even though profits are limited on a month by month basis, if they can be repeated with frequency, this can be a very effective long term strategy.
 
As you can see, a buy-write (aka covered call) strategy can be good strategy particularly when hedged by a long stock position. The worst that can happen is that you lose the potential future profits from the stock if the call buyer is able to exercise the call option you sold them.
 
This premium collection strategy has become further refined by the creation of certain combinations of stock options, which can replace the need to be long or short stock. These option spreads make it possible to participate in premium collection with much less capital investment. Two of the most popular premium collection spread strategies are the “Bear call credit spread”-usually used in flat to slightly down markets and the sister strategy the “Bull put credit spread” which is usually used in flat to slightly up markets.
 

For information on just about everything concerning stock options, contact the Options University at www.optionsuniversity.com

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