Courtesy of Phil's Stock World
If this market hasn’t convinced you that buy and hold is a gamble, I don’t know what will. Holding any stock for more than a day can be a recipe for heartache (sometimes in just an hour), but we have been having a good time during our member sessions, bottom fishing, and concentrating on plays that give us much better prices than the ones paid by the average retail investor.
Phil’s Buy/Write Strategy is a method commonly used at Phil's Stock World for establishing bullish positions in value stocks. It is a variation of one of the most effective, time-tested tools for investing in volatile markets, and it allows us to purchase shares in a company for less than the current price. As long as you are willing to own 200 shares of a stock, this system can reliably give you a 10-20% discount off the current market price.
A buy/write options strategy gives you a simple method to invest in equities at better prices than those paid by the average investor.
By writing (selling) options against the stock, we collect option premiums - that's where the discount comes from.
This is a long term strategy. Currently, there are many stocks trading at multi-year lows, and it’s important to select ones that have strong underlying fundamentals. Another sound investing principle is to scale in, because our timing is rarely perfect and the market is quite volatile. Selling options simultaneously with buying a stock is one way to automatically scale in - to enter a position in stages.
Selling puts and calls against a stock is a way to automatically follow the scaling system.
The key is to pick stocks that are:
- Trading near lows/undervalued
- Fairly volatile
- NOT likely to go bankrupt
- Either pay dividends or have good growth
- Have a clear path of continuing contracts to write
- You don’t mind owning the shares long-term
The great thing is – there's always an option.
We have featured over 100 of these "Buy-Write" plays in member chat. They offer a good way to capitalize on volatility while hedging risk. If the market flatlines or declines, we are positioned in stocks at good prices that can generate a reasonable monthly income – which will keep us flexible in a challenging market!
****
Example Buy-Write Trades
United Therapeutics Corporation (UTHR) ~ Anatomy of a Buy-Write (Oct. 17, 2011)
Below is a new trade idea from Pharmboy to illustrate the Buy/Write Strategy.
For a stock that has strong underlying fundamentals at a good price, Pharmboy decided on UTHR for this example.
Phil’s Buy/Write Strategy in Action (October 17, 2011):
Trade Idea: Buy 100 shares of UTHR ($39.20) and Sell 1 May 2012 $40 Call and Sell 1 May 2012 $35 Put for approximately $7.80 combined.
Thus, approximately $7.80 is collected in premium against the $39.20 price for the stock. This reduces the net cost to $31.40.
Three possible scenarios:
1. If UTHR trades above $40 at expiration in May, 2012, then we give up the shares purchased for $40, keeping the $7.80 premium (from selling the options) and an appreciation of $0.20 on the stock. That's a gain of $8 on an initial outlay of $31.40. The result is ~ 25% profit, and we end up out of the position completely.
2. If UTHR trades below $35, we are obligated (due to the put we sold) to buy another 100 shares of stock at $35. Our average price will be ($31.40 + $35)/2, or $33.20. Our cost for 200 shares would be 15% less than if we simply bought 200 shares of stock at $39.20 now.
If 200 shares is our full position, we can later write 2 calls against the position, and collect more option premium. If our ultimate position size is larger, we can also write a put against the position–opening the possibility of owning another 100 shares in the future.
3. If UTHR is trading between $35 and $40 at expiration in May, 2012, both the call and the put will expire worthless, and we will be left with 100 shares of UTHR for a cost of $31.40. Again, we could write another call and/or put against the position.
This is a common strategy of hedge fund managers, but anyone can do it. It is one of the best ways to capitalize on volatility while hedging risk on long positions.
*****
The latest Buy-Write idea in Stock World Weekly (Oct. 16, 2011), came from our resident biotech expert, Pharmboy.
TEVA ~ new trade idea (Oct. 16, 2011)
Pharmboy wrote, “Amidst a market run-up of epic proportions, I like selling premium. I also like buying good companies, with stable revenues, and a sizable dividend. TEVA ($39.17) is a generic drug maker that just acquired Cephalon for its drug pipeline. The stock is cheap, and revenues should be stable over the coming year.
I like buying 100 shares here, and selling the Jan. 2013 $40 call and Jan. 2013 $35 put for $9 or better.
*****
AstraZeneca (AZN) ~ previous trade idea (Sept. 18, 2011)
Note: price of AZN at the close of Sept. 16, 2011 was $44.91. On the 19th, it traded lower, between $43.62 and $44.39. On Oct. 17, 2011, it was trading at $46.64.
Excerpt from Stock World Weekly (Sept. 18, 2011 Issue):
We have a trade idea this week from Pharmboy, who wrote, “I am looking at companies that have safety for income portfolios at reasonable prices. AstraZeneca (AZN, $44.91) has a 5.3% dividend yield, a solid pipeline, steady revenues, and a forward P/E of about 7. I like buying the stock here, and, for those interested in lowering their cost via selling options premium, I like selling the January 2013 $40 calls and puts for $11.50 combined. That results in a buy/write price of ~$33.40/$36.70. It's simple and shouldn't need managing for some time.
(Editors’ note: If 100 shares of AZN are bought for $44.90 and 1 put and 1 call are both sold for $11.50 combined, that reduces the cost to $33.40. If AZN is trading above $40 at expiration, the stock will be called away and the put will expire worthless. The gain will be $6.60 on an investment of $33.40, or 20%. If the stock is below $40, it will be “put” to the person who sold the Jan. 2013 $40 put, for $40, so the new cost, an average of the first 100 shares at $33.40 and the second 100 shares at $40, will be ($33.40 + $40)/2 or $36.70.)
******
New Buy/Write Trade Ideas from Pharmboy on November 6, 2011.
Pharmboy's Trade Ideas
This week’s trade ideas come from Pharmboy, who submitted the following essay. The remainder of this section is courtesy of Pharmboy.
At PSW, we focus on just about everything from virtual day trades to virtual income portfolios. As Barry Ritholtz noted, the average stock is being held no longer than seven months (in 2007). For longer term, dividend-yielding stocks, a few companies stand out. For investors looking for a mix of solid companies with more speculative biotechs, here are some ideas. Most are buy/write examples - buying 100 shares and selling 1 call and 1 put to reduce the net cost of the shares. (For more details on recent buy/write examples, click here.)
Merck (MRK, $34.02) - we initiated a virtual buy/write on MRK by selling the Jan. 2013 $40 call and $35 put for $8 (sold). We bought the stock for $37.30. Currently MRK is trading lower, but the calls and puts more than offset the lower stock price. I like initiating a virtual new spread by buying 100 shares, and selling 1 Jan. 2013 $35 call and 1 Jan. 2013 $30 put for $5.20 or better (combined).
Bristol-Myers Squibb (BMY, $31.34) - we initiated a buy/write on BMY buying 100 shares and by selling the Jan. 2013 $25 call and $27.5 put for $7.70 (sold). Currently, BMY is trading at $31. For a new virtual position, I would buy the stock and sell the Jan. 2013 $30 call and $27.5 put for $5.80 or better.
(Ed. note: Pharmboy switched from selling a higher strike BMY Jan. 2013 put in the first buy/write example to selling a higher strike call in the second example. The reason is that he thought the stock would rise when he provided the first virtual trade idea. Now, he is less confident that BMY will trade higher, although he thinks BMY should stay above $25, even if stocks trade lower.)
Pfizer (PFE, $19.66) - Not one of my favorite big pharmas. Lipitor comes off patent...but IF it maintains its dividend, I’d be VERY conservative with a buy-write. I like buying 100 shares, and selling 1 Jan. 2013 $15 call and 1 Jan. 2013 $17.5 put for $6.65 or better.
British Petroleum (BP, $43.85) - things are looking up for this oil giant, and it pays a nice dividend. I like buying 100 shares and selling 1 Jan. 2013 $40 call and put for $13.30 or better.
Sunoco (SUN, $37.65) - I like selling a Jan. $25 2013 put for $2.50 or better (trading at $2.44 now). This is to initiate a future buy of SUN. (This is not a buy-write - it's a simple Selling of a Put, which may lead to buying a position at a discount from the current price.)
Intel (INTC, $23.74) - this tech giant continues to shine. I like buying 100 shares and selling 1 Jan. 2013 $22.50 call and put for $6.05 or better.
For more trade ideas from Pharmboy, sign up for a free trial to Stock World Weekly and read the rest of the newsletter here >
*****
For a 20% discount for all PSW newsletter services, click here.
Phil's Stock World features many trades like these on a daily basis, while Stock World Weekly features highlights in our weekly newsletter… Try Stock World Weekly out FREE.
Disclaimer
Trading involves risk, including possible loss of principal and other losses, and past performance is no indication of future results. We make no representations that the techniques used in our rankings or selections will result in or guarantee profits in trading. Further, our analyses are based on third-party data, which we cannot guarantee as to adequacy, accuracy, completeness or timeliness. We accept no responsibility for any loss arising for use of these materials.
Hypothetical or simulated performance results have certain limitations unlike an actual performance report. Simulated results do not represent actual trading. Also, since the trades have not actually been executed, the results may have under or over compensated for the impact, if any, of certain market factors such as lack of liquidity. Simulated trading programs in general are also subject to the benefit of hindsight. No representation is being made that any account will or is likely to achieve profits or losses similar to those shown.