1. Buy-and-Hold Investment “Performance Enhancement”
Jim Wolcott
Orange County Traders Meeting
June 30, 2012
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2. Disclaimer This is research, not financial advice.
You assume all risks if you treat it otherwise.
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3. Buy-and-Hold Strategy
Pros
Minimal management effort
Steady dividend income
Unlimited upside
Cons
Captive capital
Volatility exposure
Unlimited downside
How can we use options to enhance returns and provide downside protection?
How far can we go without requiring any new capital?
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4. Three possible campaign approaches
Sell at-the-money covered calls every month
Modulate call “moneyness”, based on outlook
Sell out-of-the money (OTM) calls in bull markets
Sell in-the-money (ITM) calls in bear markets
Sell at-the-money (ATM) calls in sideways markets
Put on a collar and roll continuously
Buy protective puts
Finance the cost of puts by selling covered calls
Modulate the “neck size” based on market volatility
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5. Review – Covered Calls Higher strikes  More headroom
5% OTM
5% ITM
ATM
Long Stock
Higher strikes  More headroom
Lower strikes  More protection
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6. Review – Collars
Long 100 shares of stock, short OTM call and long OTM put
Constrains both profit and loss
Sometimes established for a small credit
10% OTM
5% OTM
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7. Collar extreme case: “The Neutralizer”
Long 100 shares of stock, short ATM call, and long ATM put
Freeze play -- completely decouples the position from moves in the underlying
Used for “timeout” when trader must be out of pocket, or to lock-in a price spike,
or when volatility is unbearable, or when the market is looking to crater
Trader still owns the dividends + =
Short ATM call
Long ATM put
Synthetic short stock = +
Long stock
Neutralized/ risk off position
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8. Campaign strategy 1 – Roll ATM calls
Sell 1 ATM call for every 100 shares of stock
At least 3-4 weeks prior to expiration
Go out farther if necessary to capture decent premium
Hold ‘til expiration or take profit and roll to next month, based on your energy level and risk appetite
Repeat
Issues
Limited upside
Unlimited downside
Gaps during earnings, dividend ex-dates
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9. Campaign strategy 2 – Modulating moneyness
Sell 1 call for every 100 shares of stock
At least 3-4 weeks from expiration
Set strikes = 5% OTM if bullish, 5% ITM if bearish, ATM if undecided
Come in closer to the money if necessary, to get >$.40 time premium
Monitor remaining time premium & market outlook
Roll to next month & new strike when T.Prem < $.20
Issues
Few strikes to choose from, with low-priced stocks
Whipsaws (need a good trend following indicator)
Gaps (need to sit out earnings months?)
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10. Campaign strategy 3 – Modulating collar “neck size”
Sell 1 call and buy 1 put for every 100 shares
At least 3-4 weeks to expiration
Refinement: Buy LEAPS put and sell monthly calls
Select strikes equidistant from the money, 1-2 ATR’s out?
Variation: select unbalanced strikes for neutral or positive net credit
Monitor volatility
Adjust collar width to achieve risk/return objectives
Tighten to increase protection, Loosen to increase profit
Issues
Cost (typically negative theta)
“Soft” downside limit prior to expiration
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11. Questions?
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12. For further study
“The Inside Wire”, 8/16/ Steve Lentz’s DiscoverOptions.com webinar for mentoring students (excellent options education program!)
Collaring the Cube: Protection Options for a QQQ ETF Portfolio, Szado and Kasemi UMass Amherst
Loosening Your Collar: Alternative Implementations of QQQ Collars, Szado and Schneeweiss, Fall
15 Years of the Russell 2000 Buy-Write, Kapadia and Szado, Sept
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