The Stock Option Writer
© Warren Kaplan 2011-2012
April 17, 2012
Packed with 81 stocks of consumer stocks, the Consumer Discreet Select Sector SPDR (XLY) yields 1.4% a year. This is certainly better than the current money market yield. However, the trick is to reduce stock market risk while increasing yield. The 12-month range of this ETF is $33.07-$45.56. In the last 12-months, the stock (XLY) paid out approximately $.65 in total in various quarterly payments. The next payment goes ex-dividend around June 15. The current top 10 stocks in the portfolio are McDonald (MCD), Comcast (CMCSA), Disney (DIS), Home Depot (HD), Amazon (AMZN), Ford (F), News Corporation (NWSA), Nike (NKE), Time Warner (TWX) and Starbucks (SBX).
Reviewing the option market, you can sell a put on XLY at $41 (10% below a recent high) that expires in Jan 2013 and receive $2.06. That is a lot better than the current dividend of $.65 and you need put up only $38.94 to earn it. That is a return of 5.43%. Because that is only 9 months away, the annualized yield jumps to 7.23%. The stock price closed at $44.55 on April 13 so the stock has to decline $3.55, which is 7.97% below the current price. Obviously, if the stock market gets into a bearish mood, this can easily happen. Hence I would never commit all of my funds at this time to this situation. Remember, as the stock price goes down, the premium you will get for writing the put will go higher. At know times, you must understand that you are an insurance company that assures the buyer of the option that you will stand by your commitment. NEVER go this on margin. I have seen perfectly good investors lose their money by leveraging their investment. If you feel that the stock market and in particular, consumer stocks will go down, then wait before writing a put option. I know you want to keep your money working but the idea is to reduce the risk. You can limit the risk by selling a put and then buying a put that is under the strike price you sold at. So, for example, you can sell the Jan 41 put and buy the Jan 39 put. That limits your risk to 2 points ($200 per contract). The current spread is $.29. So, you are risking $200 to make $29. If XLY is above $41 come Jan 19, 2013, then you will have made 14.5% on your investment. This type of option is called a spread. If your investment advisor does not know how to do this, then fire the person.
The reason I like the XLY is because you do not have to worry about the ETF going out of business. Did you know that Kmart went bankrupt and shareholder lost everything? Also RH Macy went bankrupt in 1992; according to Steve Forbes book “Power, Ambition, and Glory”. The older investor may remember Korvette, a retailer in NYC and Crazy Eddie another retailer and Borders a book retailer and Boscob a retailer. All filed bankruptcy. Well, the XLY continued on its way and never was wiped out. No one can tell you which companies will surely be around in 5-years. You need to be able to sleep at night and not worry about phony accounting or government intervention. Longer term as our economy grows, the consumer will mean more and more to business. The winners stay in the XLY ETF and the losers are dropped. On average, because there are 81 companies in that index, the average is a stock holding is 1.23%. Sure the current top 10 are greater than that but that to changes in time.
If the market has a huge drop then I will show you some aggressive strategies for making money in a truly depressed market. Meanwhile, play is safe and do not use all your allocated funds for any ETF at this time. Remember, if the market goes down, you will receive a bigger premium for writing options. Also, you can reduce risk by writing options at lower strike prices.
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 firstname.lastname@example.org.