People fear options trading, and rightly so. However, it can be a good tool for hedging stock positions, so when done correctly can be safer than being invested in a 'safe' manner such as in a passive index strategy.
One strategy that I am currently exploring is a straddle between taxable and advantaged accounts. In theory this is a very good way to create income safely. However, I am still wrapping my head around certain IRS regulations that pertain to this specific type of investment. Here's a good post on the topic for those interested: http://seekingalpha.com/article/1109941-stocks-options-taxes-part-vi-options-and-tax-straddles-covered-calls
Note - I WOULD NOT deploy this strategy at this stage due to uncertainty on the proper way to package the straddle. However, if we could determine that the call killed the trade, it may be interesting.
The theory:
Increase income from existing portfolio by selling covered call within IRA. This will:
The with options that have similar dates and strikes (creating a hedge) vol is going to be an important factor. However, the vol will impact pricing both on the acquisition of the Put and the sale of the Call, so they may offset one another.
The key with building a straddle is that you need a market. A good stock to look at for this would be a well traded one. Let's consider Apple:
Market Price $127.23
The Trade:
Sell $128 Calls for $157
Buy $127 Puts for $198
Net: Loss of $41
Note that both of these positions are considered out of the money at this moment.
Let's remember the overriding goal - to make more money! As such the above strategy isn't ideal, because the Net is a loss of $41. However, from a balance sheet perspective the following occurs:
Taxable Account -$198
Advantaged (EG Roth) Account +$157
As you can see, we can theoretically garner a capital loss of $198 and also create a capital gain of $157, but the gain is shielded. The challenge is determining whether the IRS will allow you to do this with regard to the straddle rules. If they did, then even a losing trade makes money, and also has the added value of shifting money into a Roth via investment gains.
What's more.. there will be trades that net a profit.. there are a few reasons that the puts are more expensive in the AAPL example above. The most obvious one is that the price of the stock $127.23 is closer to $127 than $128 and therefore has less far to travel to make the Put in the money.
Outcomes:
The beauty of a straddle like this is that there can only ever be 3 possible outcomes:
In the case of AAPL:
1. If the Put ends in the money the Stock price has dropped below $127, this means that for 100 shares:
Max Loss stock price drops to $126
Buy AAPL at $12723
100*$126=$12600
Net Loss of -$123
Put Premium Value = -$98 ($100-198)
Call value (earned) = $157
Total Loss if Stock drops= -$64
2. If the Call ends up in the money the stock price has risen above $128 this means that for 100 shares:
Stock gains $77+ anything above $128
Put expires, losing $198
Call caps gain at $128, anything above is excluded.
Max Gain on trade $121
Proof Max gain price raises to $129
Buy AAPL at $12723
100*$129 =12900
Net gain of $177
Put premium paid -$198
Call value $57( $157-$100)
Total Gain if stock raises= $121
3. If both expire, the stock would be priced between $127-$128. The gain or loss would be related to the premium spread (-$41). It is possible for the stock to gain (eg end at $127.89) or decline in value (eg end at $127.11)
Note that I skipped over ATM prices for clarity in the above.
The goal of this strategy is to benefit most when the price ends somewhat flat. Note that the holding period for the investment is only 2 weeks in this example. Additionally, the value is that we are trading within an advantaged account, such as a Roth. This means that if the price rises (resulting in a trade execution) we don't need to worry about short term cap gains.
I think I'll put this one into the someday/maybe file as it can offer a lot of value, providing it is allowed by tax law!
One strategy that I am currently exploring is a straddle between taxable and advantaged accounts. In theory this is a very good way to create income safely. However, I am still wrapping my head around certain IRS regulations that pertain to this specific type of investment. Here's a good post on the topic for those interested: http://seekingalpha.com/article/1109941-stocks-options-taxes-part-vi-options-and-tax-straddles-covered-calls
Note - I WOULD NOT deploy this strategy at this stage due to uncertainty on the proper way to package the straddle. However, if we could determine that the call killed the trade, it may be interesting.
The theory:
Increase income from existing portfolio by selling covered call within IRA. This will:
- Produce income from premium (good)
- Reduces upside gain beyond a predetermined point (not good)
- Trap your investment against stop limit/loss orders (not good)
- Costs money to buy premium (not good)
- Protects core stock/etf position across the IRA boundary (good)
The with options that have similar dates and strikes (creating a hedge) vol is going to be an important factor. However, the vol will impact pricing both on the acquisition of the Put and the sale of the Call, so they may offset one another.
The key with building a straddle is that you need a market. A good stock to look at for this would be a well traded one. Let's consider Apple:
Market Price $127.23
The Trade:
Sell $128 Calls for $157
Buy $127 Puts for $198
Net: Loss of $41
Note that both of these positions are considered out of the money at this moment.
Let's remember the overriding goal - to make more money! As such the above strategy isn't ideal, because the Net is a loss of $41. However, from a balance sheet perspective the following occurs:
Taxable Account -$198
Advantaged (EG Roth) Account +$157
As you can see, we can theoretically garner a capital loss of $198 and also create a capital gain of $157, but the gain is shielded. The challenge is determining whether the IRS will allow you to do this with regard to the straddle rules. If they did, then even a losing trade makes money, and also has the added value of shifting money into a Roth via investment gains.
What's more.. there will be trades that net a profit.. there are a few reasons that the puts are more expensive in the AAPL example above. The most obvious one is that the price of the stock $127.23 is closer to $127 than $128 and therefore has less far to travel to make the Put in the money.
Outcomes:
The beauty of a straddle like this is that there can only ever be 3 possible outcomes:
- The Put ends in the Money
- The Call ends in the Money
- Both the Put and the Call Expire
In the case of AAPL:
1. If the Put ends in the money the Stock price has dropped below $127, this means that for 100 shares:
- Stock loses $23+difference between $127 and Zero.
- Call expires, adding $157
- Put gains in value in direct proportion to the stock loss
- Max Loss on Trade = $64
Max Loss stock price drops to $126
Buy AAPL at $12723
100*$126=$12600
Net Loss of -$123
Put Premium Value = -$98 ($100-198)
Call value (earned) = $157
Total Loss if Stock drops= -$64
2. If the Call ends up in the money the stock price has risen above $128 this means that for 100 shares:
Stock gains $77+ anything above $128
Put expires, losing $198
Call caps gain at $128, anything above is excluded.
Max Gain on trade $121
Proof Max gain price raises to $129
Buy AAPL at $12723
100*$129 =12900
Net gain of $177
Put premium paid -$198
Call value $57( $157-$100)
Total Gain if stock raises= $121
3. If both expire, the stock would be priced between $127-$128. The gain or loss would be related to the premium spread (-$41). It is possible for the stock to gain (eg end at $127.89) or decline in value (eg end at $127.11)
Note that I skipped over ATM prices for clarity in the above.
The goal of this strategy is to benefit most when the price ends somewhat flat. Note that the holding period for the investment is only 2 weeks in this example. Additionally, the value is that we are trading within an advantaged account, such as a Roth. This means that if the price rises (resulting in a trade execution) we don't need to worry about short term cap gains.
I think I'll put this one into the someday/maybe file as it can offer a lot of value, providing it is allowed by tax law!
