Active investing gets a bad rap. People see it as a gamble on the marketplace, a risky venture to make a few quick bucks. They advocate investing in an index fund, which is seen as much safer and a way to generate larger returns.
I feel as though active investing has been both underrepresented and misrepresented in the marketplace. I’m going to attempt to make a fair case for it (yet again) but through a different avenue than I did previously.
There are two different options trading strategies that I am going to discuss, one involving a call, and the other involving a put. Both of these trades are a bit out of my personal trading price range, but they should be feasible for the average investor (not a college student, unfortunately!).
The Covered Call: buy 100 shares of stock and sell an 2 standard deviations (32 delta) OTM Call with about 45 days left to expiration.
This trade caps the upside at the call strike we sold, but the premium collected provides us with downside protection and a reduction in cost basis. So let’s say we buy 100 shares of Costco, which will cost us $16,730.
That’s a daunting number. Luckily, we can sell a call against it at the 170 strike that provides us with an additional $193 of premium. Also, the stock now makes money if it is above $164.8 ($166.73-1.93), rather than just $166.73.
We have effectively reduced the amount of money we have to pay for the trade and get some downside protection (a $1.93 might not seem like a lot now, but at expiration, those pennies and dimes matter a lot!)
However, we do cap our profit potential at any share appreciation above the short call. So the max amount that we can earn on this trade is about $500. BUT we increased our probability of profit to about 60% (versus just being long stock with only a 50% POP) and collected some additional money to reduce the overall cost of the trade.
We can also trade something called a cash-secured put. This is basically just selling an put about 2 standard deviations below the stock price. This is a unique way to purchase 100 shares (upon expiration) at the strike price of the put and collect some additional premium.
Taking Costco again, we can sell the 160 put for $105 (which is also our max profit) and as long as the stock price stays above 160, we can get consistent profits.
Both options have lower potential losses as compared to just buying stock outright. We want to enter trades like these when the stock price is low and implied volatility is high, and looking for that 2 standard deviation option.
The gist of it all, is that covered calls collect premium against shares that we already own, whereas cash secured puts collect premium while the stock remains above the stock price.
So rather than go for a 50/50 shot in just buying stock, collect some premium and increase your probability of profit with these trades. Your account will thank you!
Disclaimer: These views are not investment advice, and should not be interpreted as such. These views are my own, and do not represent my employer. Trading has risk. Big risk. Make sure that you can balance your risk/reward, and trade small, and trade often.
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