CONSERVATIVE OPTION STRATEGIES INCREASE PROFITS

"The options-based strategies can be useful in improving the risk-return characteristics of a long equity portfolio."

Although this paper goes into more specific option strategies that other studies, the results are very similar: Basic option strategies accomplish two useful things for conservative investors.

First, returns are modestly enhanced. Please note the word "modestly." I am not telling you that using options will make you rich. But, over the longer-term, you can anticipate being farther ahead when using some option strategies as part of your overall investment plan.

Second, the value of your portfolio undergoes smaller changes (i.e., smaller ups and downs).

"Ignoring early exercise for simplicity, we find that the covered combination and covered call strategies generally outperform the long stock strategy, which in turn generally outperforms the collar and protective put strategies regardless of the performance measure considered. "

Thus:-

·         Writing covered calls generally outperforms the buy and hold (stocks) strategy.
 

·         Writing covered combinations (i.e., owning 100 shares of stock and writing one OTM call and one OTM put) outperforms the simple buy and hold strategy.

However, owning stock produces better results than ultra-conservative strategies. That is understandable, because the primary objective for very conservative investors is the preservation of capital, with the ability to earn a good return being of secondary importance.

·         The collar strategy does ensure that the investor's losses are limited, regardless of how far the stock price may tumble. However, the collar investor always earns less than the buy and hold strategist -- over the longer-term. In other words, insurance costs money.
 

·         The protective put strategy involves owning both 100 shares and one put option. The put generally has an out-of-the-money strike price. This is similar to the collar strategy, but does not involve the sale of an out-of-the-money call option. The investor who adopts this strategy pays a stiff price for portfolio protection, but is able to fully participate in all rallies. 
 

Equivalent Positions

Because some option positions are equivalent to others, it is not necessary to adopt the methods mentioned above in order to achieve the same financial results. For example:

·         You can sell cash-secured (i.e., if assigned an exercise notice, you have sufficient cash in your account to buy stock) naked put options instead of writing covered calls. However, please note that the expiration and strike price of the put and the expiration and strike price of the call must be identical in order for the results to be equivalent.

·         You can sell two put options instead of writing covered combinations. One of the puts is in the money and the other is out of the money. In other words, sell one put with the same strike price as the call portion of the combination; also sell the same put that you would have sold in the covered combination.
 

·         Instead of owning a collar position, you can sell a put spread with the same strike prices and expiration as the collar. Translation: buy the same put option, but instead of buying stock and selling a call, sell a put with the same strike and expiration as the call.
 

·         The protective put strategy is the same as owning calls instead of stock. The strike and expiration of the purchased call is the same as that of the put that you would have bought for protection.

It is important to recognize one characteristic of the chosen option strategy: 

·         The strategies that produce increased  long-term profits involve selling option premium (i.e., collecting cash when trading options).
 

·         The strategies that provide better protection against a stock-market disaster, but which result in reduced profits (compared with just owning stock and avoiding options), involve thepurchase of option premium.