September 13, 2011
When should you use a straddle? This is when you are not sure if the stock price is going up or down from its current point but you like the basic company and would not mind owning it around the current price.
Verizon (VZ-NYSE) is selling at $36.00. You want to buy 200 shares. (Straddles only work with even number 100 unit shares i.e. 200, 400, 600 etc).
Verizon pays a dividend of $1.95, which is a yield of 5.40% at the current price. The next ex-dividend date is approximately Oct 6, 2011.
You buy 100 shares at $36.00. Now, you sell the October $36 call for $1.11 and at the same time, you sell a put at $36 for $1.47. In other words, you straddle the stock at $36.00.
In effect only one side will win on Oct 22, 2011. If the stock is at $35.99 or lower, you will be buying second 100 shares. Since you received $1.47 for the put, your effective cost is $34.53. The $1.95 dividend then produces a yield of 5.65%. And, you have the earned the $1.11 that you received from the sale of the call at $36.00.
When you sold the call and bought the stock at $36.00, you only had to layout $34.89 as you received a premium of $1.11. So your dividend yield is really $1.11 divided by $34.89, which equals 5.59% instead of 5.40%. Also, you will receive a dividend of $.4875. If the stock gets called away on Oct 7 or sooner, you will not get the dividend but your obligation is over and you made a profit of $1.11 on your cost of $34.89 for a gain of 3.18% in 5 weeks. That translates to an annualized rate of 33.09%. What about the put side? Well, you are still obligated to buy 100 shares at $36.00 until Oct 22, 2011. Keep in mind that you were paid $1.47 for the put and you already pocketed $1.11. If the stock is not called away on Oct 7, 2011, you will receive the dividend on the 100 shares that you own bringing in an additional $48.75.
What to do if, on Oct 22, 2011 you are put the 100 shares at $36.00 and you already had the 100 shares you bought at $36.00? You are now long 200 shares at the reduced cost. Of course you can sell new calls at $36.00 or even $37.00 with January 21, 2012 expiration. The company should declare another dividend to holders as of January 9, 2012 or thereabouts. Your dividend will probably total $87.50.
Even now, you could do a January 2012 straddle. The stock price is $36.00 and so you can do a January 22, 2012 straddle and receive $1.68 for the call (you would also receive $.875 in dividends if the stock is not called away before January 9, 2012) and you will get $2.46 for the put, reducing your cost on the second 100 shares to $33.54. The second 100 shares, if put, would give you a yield of 5.81%. Of course you can then turn around and sell a call against any shares you got put. That would give you more premiums thereby reducing your stock cost and further improving your percentage yield.
This strategy can be used in IRA accounts and are best used to enhance yields. The worst of times is when this strategy is used and abused in a margin account, on leverage, and the stock market collapses. If you use this strategy in a cash account, you will not get a margin call and if the company you have is decent and continues to grow, then you will make money.
By the way, even ETFs (Exchange Traded Funds) go down but they do not go out of business or wipe out shareholders in a Chapter 11 proceeding. I will write about certain strategies I use to enhance income from ETFs in up coming issues of Opportunist Magazine. Meanwhile I would appreciate your comments and questions.
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.”
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