The Stock Option Writer
© Warren Kaplan 2011-2012
August 14, 2012
I love ETFs. Why? Because they are inherently a safe investment for the future. Sure, you can buy them at the wrong time and worse, sell them at the wrong time. However, if you think like Warren (no relation) Buffet thinks, namely long term like 10-20 years into the future, it is hard to see how this ETF could go wrong. The world consumes more energy and no matter where it comes from (oil, gas, solar, wind, coal, nuclear, chemical, hydropower or anything that will be invented), the fund will have the companies that are involved in providing us with the supply. No need to worry about any accounting matters or anything stupid that a management might do. Jim Kramer does not like ETFs because they include the good and the bad. Well, how many of us have the time and inclination to try to separate those companies out? And, how many make mistakes? My goal is to sleep at night and concentrate on what makes me happy.
All stocks in this ETF come from the S&P 500. So, when a company is dropped like K-Mart, Bethlehem Steel, Enron, and many others, they are dropped from their respective ETF. However, this is not an article about ETFs. I leave that for your financial manager or broker to explain it all to you.
The XLE, from March 31, 2002 to March 31, 2012, with reinvestment of dividends and capital gains has grown. An investment of $10,000 was worth $29,094 in that 10-year span. You should know that the ETF got slammed hard in the big crash of 2008-09. The $10,000 which was as high as $34,000 crashed down to approximately $17,500. Hence you need to be a long term believer.
The current 12-month yield is 1.7%, which is a lot better than the money funds .05%. It is better than the current 10-year US government bond yield.
The XLE closed at $72.37 this past Friday. You can try to enter the stock at $70 by selling the Sept. 22 (6 weeks from now) put and take in $1.06. Considering the stock’s estimated pay out of $1.23 a year, you can see that selling the put is a much smarter idea. If the stock stays above the $70.00 point you will not be put. You would have to post $68.94 in order to effect this investment. Your potential annualized return is 13.32%. If you did get assigned and you bought the shares, you can turn around and sell a call.
Then the next ex-dividend date is around December 20nd, and with the stock price below $70, you should be able to get another $2.00 for selling the January 19 $75 call. The result is a reduced cost to you and your investment would now be $66.94 and if the shares got called away in January 2013, you would have a capital gain of $8.06, which delivers an annualized gain of 28.90%. If the stock only gets to $74.98, you will not sell the shares at $75.00. However, you can sell a new call at an even higher or lower strike price and take in more premiums.
There are various strike prices on the XLE and you need to pick one that you believe in. You have to decide on what price you want to pay for the stock and at what price you would be willing to sell it. With the XLE, you can sell options as far out as January 18, 2014. The highest option price currently available is $105 (currently you would only get about $.50 for that option) and the lowest strike price is $33 and you can sell that put for about $.95. That annualizes out to 4.20%, which is a lot more than what the current stock pays. Also, for that stock to get down to $33, it would mean that we have had a horrible crash and the planet would be in disarray. Of course this is my opinion and the buyer of the option is thinking something else. Keep in mind that your funds are tied up until the option expires unless you decide to buy back the option you sold and thereby close out the transaction.
For January 18, 2014 you can sell the $40 put and take in $1.31. You need to layout $38.69 and your annualized yield would be 4.80%. For me, this is the kind of invest I would make if I just wanted to put money away for 17 months. That yield is a lot better than the current .80% you can get on an 18 month CD.
Writing option s is not a mystery. You need to slowly gain experience and if your financial advisor does not understand option writing, then you should fire them.
I consider ETFs such as XLE to be an excellent candidate for long-term dollar cost averaging and you can write covered calls and cash covered puts in your IRAs.
Warren Kaplan has been writing options for 50 years. He has been a stockbroker, investment banker and brokerage owner. He currently owns and operates Kaplan Asset Management, a provider of financial assistance for small to middle market businesses. He has more than a half-century of experience in dealing with financial markets, giving guidance and consulting with management, and assisting in the development of business strategies and solutions. The Company has assisted and consulted many successful companies, such as Natures Bounty (NBTY) and Action Products International (APII), helping them to go public and trade on the NASDAQ stock exchange. His philosophy is to “do something with the profits.” “If you make $100 in the stock market, take 50 percent and invest it back into the market. Then, take the other 50 percent and buy yourself something.”
Reader’s comments are welcome. Please do not consider these opinions as advice and we take no responsibility for any trades made. You should review these option writing ideas with your financial advisor so that you are properly guided. Writing options is not for everyone. If you want information about a certain stock, please email email@example.com.