By Warren Kaplan
The Stock Option Writer
© Warren Kaplan 2011-2012
August 28, 2012
OK, I expect the market to go soft in September. Actually, September has shown itself to be the most down month in a year. That is real good for those of us who write put options. Why? Because we can look forward to greater premiums and we can reduce our risk by writing options at a lower strike price. Yet, in order to increase safety, I focus on ETFs. One group of ETFs that is liquid and option able is the SPDRs.
Currently, I like the XLF (Financial) and the XLE (Energy). Both of these ETFs harbor volatile stocks. Keep in mind that all SPDRs are composed only from the S&P 500.
The December XLF put option at $14.00 will currently bring you $40 for each contract. Well, if the market will dip the way I think it will, you can place an open order to sell that option for $50 per contract. If you do write that option, you will annualize out to 11.11%. You will have to wait 4 months to see how that played out. The XLF closed at $15.13 on Friday, August 24. Never go all in. If there is a war with Iran, you will be able to sell that option for a lot more money. If you get $60 per contract, your annualized return, assuming there are 4-months to go, would be 12.86%. It would not take much to knock the XLF down to $143.00 from its current price. If Iran is not attacked and all we get is a down September, I can see the XLF backing off to maybe $14.70 and easily receiving the $50 per contract that I mentioned. Since some time period will have happened, the actual annualized yield would be more than 11.11%. Another way to use option writing is to write a call. You can buy the stock $15.13 and sell the December $14.00 and receive $1.43 per share. That reduces your cost to $13.70 and where a current buyer is getting an annualized dividend yield of 1.69%, you would be getting 1.87% and you would have the opportunity to pick up another 2.19% in 4 months (6.57% annualized). Keep in mind that the S&P financial stocks once sold for a much higher price. I do not believe the bull market is over. However, I do think a lot of profit taking and tax lose selling will take place in September.
As for the XLE, that is an Energy ETF. I have already described a strategy that replaces a CD and delivers a much higher rate in my last article. You can write January 2013 options. The stock closed at $71.98. A pull back in September could take the stock down to $70 and if oil sells off, then the Energy ETF could see $68-$69. However, a war with Iran, after an initial shock could drive the XLE much lower and then rally strongly. The January 2013 $66 strike price put might be written for $2.75 (currently $2.35) with a little downward pressure on the stock in September. You would pick up a 4.35% for the 5-months. You only need to layout $63.25 as your obligation is covered by the sale of the option. Another approach is to buy the stock now and write a January 2013 call at $66. You would receive $7.80 thereby giving you a true cost of $64.18 if the stock gets called away, you will have a profit of $1.82 for a gain of 2.84% in 5 months. However, you would receive dividends in September and December unless the option buyer calls the stock sooner. That should be OK with you as the net result increases your return. The dividends for the 5 months should bring you a total of $.62 a share. Another point to consider is that the dividends will be paid in 2012 but the gain will fall into January 2013. You will have use of the funds for the whole year of 2013 and you will not need to pay taxes until 2014. The XLE would have to fall by 12.13% for you to be at the even point. Current buyers who do not write options would be losing that 12.13% and their dividend yield would be 1.62%, annualized.
If the market had a really major sell off, then I would show you how to write covered calls for serious potential gains. However, with a DJI average of 13,150, I think the low hanging fruit of easy profits is just not there. This calls for a long-term strategy and careful stock selection. If the Iranian situation actually turns into a war and oil supplies are disrupted, you can expect a panicky market and that will mean opportunity. I suggest you review your plans now with your financial advisor so that your approach becomes automatic. And, finally, don’t forget to take some of your stock market products to go travel and to buy yourself and your family something you always wanted. Just stay out of debt.
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 corp@opportunistmagazine.com.
