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Investing Strategies?

4 well known option strategies investors use on stocks and Exchange Traded Funds (ETFs) are:

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  1. Cash Secured Put  (Low risk value investing strategy)

  2. Covered Call           (Low risk value investing strategy)

  3. Butterfly                  (High risk trading strategy)

  4. Iron Condor            (Medium risk trading strategy)

Are options risky? Yes if you do not understand the risks but not when you are familiar with it. It is similar to driving a car for the first time compare to driving it after several years.

 

'Risk comes from not knowing what you're doing' - Warren Buffett

1) Cash Secured Put

Link: https://www.investopedia.com/articles/optioninvestor/10/sell-puts-benefit-any-market.asp or click here

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  • What happens if you feel the current share price of a stock is too expensive to buy right now?

  • Or the stock price is higher than your calculated intrinsic value?

  • i.e. Current stock price of Apple = $200, Calculated intrinsic value = $190.

Answer:  Sell a put option at a strike price equal to your calculated intrinsic value i.e $190. You can collect option premiums immediately with returns as high as 10% to 20% p.a. depending on the strike price and the stock/ETF you've chosen. Usually, selling an option with 1-month expiry date gives you the highest return compared to 1-week or 2-months or even 1 year. 

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Note:  Cash secured put means you need to have the necessary cash (instead of borrowing cash) to purchase the stock/ETF on expiry date if the price falls below the strike price.  Think of it as a win-win i.e. Either you're able to purchase the stock at a cheaper price OR you just collect the option premiums $$ upfront as income.

 

Risk: Stock price might continue to fall cheaper in the short term. This value investing strategy works best for fundamentally strong companies and assumption is that the stock price will increase in the long term over the years due to growth and inflation etc. It can also be applied to ETFs.

Stock price graph

2) Covered Call

Link: https://www.investopedia.com/articles/optioninvestor/08/covered-call.asp or click here

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  • What if I purchased 100 Apple stocks at $190 each and its current stock price fell below  <$190 ? 

  • How can I make money while waiting for the stock price to rise back again?

Answer: Sell a call option at $195 or higher strike price. You collect option premiums $$ upfront as income while waiting for stock price to rise back again. If upon expiry date the stock price is higher than your strike price, you sell your stock for potential capital gains. Else you still collect your option premiums $$ and can continue to sell call options again.

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Note: Covered call means you need to own the underlying stock before selling a call option on it. 

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Risk: Selling a call option without owning the underlying stock is extremely risky because if the price closed a lot higher than your strike price upon option expiry date, you'll make a loss from the difference in prices.

Stock Trading Graph

3) Butterfly

Link: https://www.investopedia.com/terms/b/butterflyspread.asp or click here

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  • What happens if the stock price or ETF price doesn't move much historically? 

  • How can I make money from it?

​Answer: Apply Butterfly by buying and selling 2 call options each at 3 strike prices as follows: 

Buy Call option       (Lower Strike Price e.g. $180) -> Expensive option cost!

Sell 2 Call options  (Middle Strike Price, which can be at the current price e.g. $190)  

Buy Call option       (Higher Strike Price e.g. $200)

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Note: Butterfly spreads pay off the most if the closing price is near or exactly at your middle strike price upon option expiry. It is not too costly to execute butterfly with daily expiry dates and when strike prices are close to current price.

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Risk: Buying the call option at lower strike price is the most expensive. If the price closed below your lower strike price e.g. <$180 or higher than your higher strike price e.g. $200, you'll make a loss. Good thing about this strategy is you limit your losses to the cost of buying 2 call options.

Butterfly

4) Iron Condor

Link: https://www.investopedia.com/terms/i/ironcondor.asp or click here

 

  • What if I wanted to apply a bigger price range instead? 

  • Is there other strategies less risky than Butterfly? 

Answer: Apply Iron Condor by using Bear Call Spread + Bull Put Spread

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E.g. Current Price  $1000

Bear Call Spread 

  • Buy Call option @ $1120

  • Sell Call option @ $1100

Max Profit if price goes below $1100

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Bull Put Spread

  • Sell Put option @ $900

  • Buy Put option @ $880

Max Profit if price goes above $900

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Note: Iron Condor is good strategy if you foresee minimal price movement on the asset e.g. after a large price move due to news or high-volatility event such as dividend payout etc. It is not necessary to hold iron condor position until expiration, sometimes you can close position for larger profit before expiry. Works best for monthly expiry dates with wider strike prices far away from the current price.

 

Risk: Might be a safer strategy compared to Butterfly since your chances of 'winning' is higher with wider strike prices e.g. between $900 to $1100. However, it comes with a potential lower return since the maximum return you can get is the net option premiums received from selling options in an iron condor trade. (Less all the option trading fees of course!)

Condor bird
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