After a 32% gain in the U.S. stock market in 2013 only a Pollyanna would expect more of the same, without profit-taking, rebalancing, and sector rotation. I recently wrote of a defensive investment strategy that, in my opinion based on thirty years of option experience, has both a high degree of safety and a lofty double-digit return - selling LEAP Strangles ( put & call straddles with different strike prices).
Having tested this strategy so far with 20 positions, I'd like to present three of the latest positions with projected yields. (These trains have probably left the station, so are not to be considered recommendations, as exceptional as they may be) :
On August 16 of last year I purchased 500 shares of Trina Solar (TSL) at $8.97 a share, ($4494 incl. commission) while simultaneously selling a covered call (Leap) of 2015 - the $10 strike price-, for $1211, and selling the same Leap expiry put - the $8 strike- for a credit of $937. The intent was if the stock remained, or at least returned to, the same $9 price on Jan. 2015' third Friday, both options would expire worthless and I would keep the combined $2148 for a 47.8% profit, only to repeat the process with another two year Leap Strangle.
However, as it turned out, the stock went on a tear, doubling in the next few months, so I decided to raise both the put and call strikes to match and bring in more "security" money. In a trade off, this does increase the risk a bit, especially when you upgrade the call for a debit, to release more of the take-away price from the call- from $10 to 15, released $2500 and cost me a debit of $597. Raising the put was for a net credit : $1353.
If the options expire worthless and I sell the stock at its current price - $14.40, my return would be 135%, or $6083, thanks to the fine-tuning for the stock appreciation.
The next two examples are a bit simpler, sans rollouts - making the monitoring almost nonexistent:
YRC Worldwide trucking, at $18.90 a share on January 7 of this year, fell within my boundaries; the Implied Volatility (IV) on the options, which normally falls within the 20 to 30 range, was 100 and 120, meaning the prices were huge! By buying 300 shares ($5679) and selling the 2016 expiry 20 call and 17 put ($2599 and 2839, or $5438) I got almost all my investment back immediately! Since Volatility usually indicates a fragile situation, the stock dropped to almost twelve within a few short days, but rebounded back to its current $21 level. Should the stock remain here or above, returns would be $11,438 less the $5679 ( $5759) or over 100% (doubling my investment over two years.
Of course, there is the possibility of the stock dropping below the $17 put strike and more stock would be put to me, unless I closed it out beforehand.
The final example is on an ETF - the triple strength Gold NUGT which has Leaps. On February 6 I bought 100 shares for $35.95 - well out of the $5-20 LEAP Strangle range- but again I could not resist the IV of 93/98. NUGT shares cost $3604 (with commission); options brought in $1544 and $1380 - $2924. The put strike price for 2016 (at which time I assume gold will be higher) was $30, and the call at $40- room to run, both ways.
Finally, doing the math on this trade: If NUGT stays or settles at the initial price of $36, two year return will be 83%; if it rises to $40 or above (called away) - 94%.
If it falls and stays below 30, both the put and stock will lose money as the call gains by decay - occasional monitoring of gold will be prudent. If slightly below 35, one might consider another two-year collar (strangle) since they own the ETF already.
Full disclosure: Low-priced stocks can be an indication of weakness - they can go bankrupt, Pink Sheets (OTCBB), or candidates for mergers or takeovers, in which case option treatment will vary. Stocks mentioned above, as well as the LEAP strategy, are only for informational use, not recommendations. Common sense and brokers' requirements dictate a fairly extensive knowledge of options and their dangers. None of the above pay dividends - this may also be a positive factor. Cost basis will differ if done in a tax-deferred (IRA) account where loss sequester is required, not margin equity from stocks. Laddering trades out 2 or 3 years might be a wise diversification; also even options can benefit from longterm capital gain tax treatment.