If you think the market is about to take off for the stars (10% to 20% gain) in the next thirty to sixty days, then you can stop reading this article right now. But if you feel stocks will stay in a limited trading range or go down, and you would like some low risk investment strategies designed to preserve capital, reduce risk, generate cash, and make index beating returns then read on...
The next step up from basic covered call investing is spread trades. With covered calls, you still take on some risk associated with a drop in stock price, but with spreads, the potential downside can be limited.
When you do spread trades like these, you have less money on the table but you make less money, too. You might only receive $250 profit per trade, but put on ten of these every month and it adds up. The risk is relatively low and you lock in your return up front. The key is that you can make money in a down or flat market without actually paying money for the stock and taking on the full risk of a drop in stock price. You conserve capital and bank a small profit. Not a bad plan in this market environment.
Here are three types of spread trades to consider in this market environment:
Bear-Call Credit Spreads
When you generally feel that a stock is going to stay stable or drop, you might consider a bear-call credit spread. If a stock is at $55 and you feel it is unlikely that the stock will go to $65 over the next 45 days, you could do a Bear-Call spread (sell a 65 strike price call and buy a $70 strike price call) for around $0.25 a share. For 10 contracts (1,000 shares) you would receive $250.
Bull-Put Credit Spreads
When you feel a stock is going to stay in a certain trading range and not drop drastically, this may be the right strategy. If a stock is at $55 and you feel it is unlikely that the stock will go below $45 over the next 45 days you could do a bull-put spread (sell a 45 strike price put and buy a $40 strike price put) for around $0.25 a share. For 10 contracts you would receive $250.
Calendar LEAP Spreads
When you feel a stock will go up or stay stable over the long term (6 months to several years) this is a way to take a position in the stock without the full risk and expense of actually buying the shares. If a stock is at $55 and you feel it is unlikely that the stock will be below $45 in January next year (or the year after), you could do a calendar LEAP spread (buy a January 45 strike price LEAP call and sell a $65 strike price call less than 40 days out) and pay around $17.65 instead of the $54.65 it would cost to do this trade as a covered call. If the stock hits $65 by the sold call expiration date you have pocketed about a 13.3% return over the period or more than a 130% annualized return. And if the stock stays below $65 you can sell another call and collect more cash.
With credit spreads you get your cash up front and eliminate trades (and commissions) needed to close the transaction. You should be able to do these trades in your IRA/ROTH retirement accounts since they have a defined risk.
This uncertain market is the best time for investors to use covered calls, spreads and other cash-producing option strategies to hedge their portfolios. You make these transactions with your broker, similar to buying and selling stocks.
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