The Stock Option Writer
© Warren Kaplan 2011-2012
September 12, 2012
History has shown that September has been the downiest month of the year. With the DJI at the 13,000 levels, it just may be a good time to invest with safety being the main aim. So the idea is to limit risk and still make more income than what you can get in the money funds.
The XLP is the SPDR for consumer staples. On June 30, 2012, the portfolio’s top ten holdings consisted, in order of importance, of Coca-Cola; Procter & Gamble; Philip Morris Int’l; Wal-Mart; Kraft Foods; Altria Group; PepsiCo; CVS Caremark; Colgate-Palmolive and Costco Wholesale. That index (not the ETF) was up 2.61% in August and is up 9.76% for the year not counting dividends. Based on 12-month momentum, the index is up 16.06%. The 52 week range is $28.70-$36.00. Grounded on the must-read book “The Seven Rules of Wall Street” by Sam Stovall, this index (XLP) is rated a buy among indexes if you are using the strategy as outlined in the theory “There’s Always A Bull Market Someplace”. Sam Stovall is the Chief Investment Strategist of Standard & Poor’s Equity Research.
The stock (XLP) closed at $35.46 on Friday August 31, 2012. The dividend yield in the last 12-months is 2.58%. I would expect a stock pull back in Sept. to the $33.50 -$34.00 level. I do not see a bear market starting in September, just a normal pull back and a typical September down month. If I am right, you should be able to garner above average premiums for writing put options. You can try a buy/write strategy if you really want to be long the stock.
Right now, the September $34 put can be sold for a premium of $.10. This is only for 3 weeks. That is equal to an annualized payout of 5.10%. If XLP goes down, you should get a higher premium. In this case, because the period to expiration is so short, you may not be able to get much more premium. However, the October $34 put premium is approximately $.29 and the annualized yield is 6.34%. If the stock price goes down soon, you will be able to get a much better price. Also, the current stockholder will get the September dividend of approximately $.23. Going further out in time, namely January 2013, the put on the $34 strike price will bring you $.83 and an annualized yield of 5.86%. The holder of the shares will receive about $.46 in dividends. However, the January 2013 option will be sensitive to price movement of the stock and you can expect to get a lot more money if XLP sells off in September. If you get $1.00, the annualized yield is 7.06%. Actually, because you would only have to post $33 and not $34, your yield is greater. Just be sure to keep your commission costs as low as possible. The best way for you to get the higher premium is to put in a Good Till Cancel (GTC) order and be patient. The closer the stock price gets to $34, the higher the premium you will get. The premium decay of time will not be a huge factor at this point on the January 2013 option but will be a huge factor on the September and even the October options. As stated, there are only 3-weeks left for the September options. A stock decline from $35.46 to $34 represents a decline of 4.12%. Unlike stocks, ETFs like XLP do not move with blinding speed. Generally, the movements are slow and steady, in either direction. Keep in mind that the DJI averages are at 13,000 and not 9, 000.-10,000. Some caution is warranted and as a precaution, you should be reducing your exposure. You can take out money from your account to prepay your mortgage or eliminate credit card debt. Maybe it is time to take a cruise or an adventure in Europe or China. Just be sure to pay for it now and not take on any new debt. Certainly it is time to weed out any stock margin, which I do not advocate for anyone but a true professional and even now, the true professional should be reducing exposures.
If you have a bullish outlook for the market and less time to be involved, you can write the January 2014 XLP and with a $34 strike price, you will currently receive a premium of $2.75. With 17 months to go, the time decay is meaningless. A decline in the stock price will allow you to receive $3.00 and even more. Again, this requires patients and the use of a GTC order. By the way, GTC orders are only good for 60 days and are not adjusted for any dividends that the ETF pays out. You need to post only $31.00 if you put in an order to write a put at $34.00 and receive a $3.00 premium. If you receive $3.50, you need to post only $30.50.
This is not an aggressive strategy but then again, the stock is not at a relative low price. It does have upward momentum but that can change. Writing options depends on your personal goal, ability and time to achieve your goal. Your money manager, if you are using one, shouldn’t be the only person taking money out of the account.
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.