Simple-to-Execute Option Investment Strategies

Okay, hang onto your hat… both investment strategies involve the use of options.

No, not the scary, complex ones. The simple-to-execute options that can actually prove extremely valuable in any market - but particularly one like this.

Buying options is easy enough.

   * When you buy calls, you’re simply betting that a stock will rise.  
   * When you buy puts, you think the stock will fall.  

But this is no different than placing a short-term bet on the direction of a stock or index - something that is very tough to do consistently. And because of volatility, you will overpay each time you buy an option.

A better way to play the options market is to understand what happens when you sell options. This is the “other side” of the trade - the infinitely more profitable side of volatility and a more consistent way to make money from the stock market. Profit From Market Volatility #1: Using Covered Calls

Market volatility is so rampant today because investors are uncertain about the direction of stocks in the short-term. No surprise there.

But with daily double-digit swings and volatility so high, the price for buying options has shot through the roof.

That’s bad news for suckers, but excellent news for us.

That’s because the first way to profit from market volatility is to sell calls against stocks that you own or that you want to buy. When you sell an option, you get a lot more money. In fact, you get the money upfront and it’s yours to keep, no matter what happens.

I’ll give you an example of this volatility at work…

Last month, Wells Fargo (NYSE: WFC) traded between $9 and $20. For a bank stock, that $11 range is very wide (of course, we all know why that happened). By comparison, the stock traded between $29 and $34 - a $5 range in February 2008.

In percentage terms, the numbers are much more revealing. In February 2008, WFC traded with swings of less than 20%. But last month, those swings rocketed to more than 100%.

Simply put, this means the cost for WFC options with a strike price at-the-money (at or near the current price) on any given day last month was between 3 and 4 times the price at the same time last year.

So let’s say that WFC was trading at $10. The $10 option this year with a one-month expiration would have cost you over $2.50. Last year, a corresponding at-the-money option with a one-month expiration would have cost less than $1.

So the lesson here would have been to buy WFC shares and then sell call options against them to reduce your cost and protect your downside.

That’s one way to beat market volatility. Here’s another… Profit From Market Volatility #2: Selling Put Options

What if you could make an investment where you could choose the price you want to pay for a stock and don’t have to pay for the shares unless the price falls to that level?

Oh, and also get paid money upfront, just for trying?

That’s the essence of selling put options.

When you sell a put option, you receive the cash from the sale in your trading account immediately. In return, you’re then obligated to buy the shares if they fall to your strike price at or before expiration.

Let’s look at an example of how market volatility and put selling are a marriage made in stock market heaven…

Let’s say that Microsoft (Nasdaq: MSFT) is trading at $15 - a ridiculously low level for a cash-rich, debt-free company.

Because MSFT is moving with such volatility, the price for buying call options or put options is extraordinarily high. Forget that. You decide that you’d like to own MSFT at $12.50 - a price not seen since 1997 when the company was one-quarter the size it is today, with much less cash on the books. At $12.50, you’d own MSFT at 3x cash and 5x earnings - an outstanding bargain in any market.

Here’s what you’d do… 

• Sell the MSFT $12.50 put options for $1. If you sold 10 contracts, you’d be “paid” $1,000 immediately because 10 multiplied by 100 (the options multiplier, because one contract is made up of 100 shares) is $1,000.
• You’d then be obligated to buy MSFT at $12.50 if it closed below that level. So be careful not to sell more contracts of shares that you can afford to buy.
• Your ultimate cost would be $11.50 per share (accounting for the $1 option premium) - a full $6.50 below current levels.
• If MSFT does not close below $12.50, you’d keep the cash - basically getting paid for trying to own MSFT at your price.

Once again the volatility of MSFT is 47 - more than double its historical volatility. And that volatility results in massive option premiums - which you receive as the seller.