Using Options Strategy to Amplify Your Long Term Stock Holding Returns

Options can Amplify your portfolio return

Do you know that Warren Buffet also uses options strategy to amplify his portfolio?

Options is a derivative instrument that can be used safely to generate extra income or lower down the cost of buying a stock.

With the right strategy, one can increase the return to a much higher rate than the typical retail investor.

This is one weapon that a professional needs to have in his armor.

One of the options strategies that I have been using is Cash Secured Put.

With this strategy, you can earn about 10% to 20% return per stock.
(Note: returns can vary depending on the stock, volatility and the premiums collected).


I list down the summary of the steps as below:


Steps to Using Cash Secured Puts Options Stregtegy


Step 1: Identify a good quality business (stock) using fundamental analysis
- Ensure this is a profitable company for at least 5 years - consistent is key
- Low in debt, or manageable debt
- Strong cash flow
- Good growth potential in earnings or dividend
- Good management
- Strong economy of moat - possesses a strong brand and stickiness
- Try to buy the stock below the intrinsic value. This will provide a margin of safety. The guideline will be about 20% to 30% below the intrinsic value.
- Make sure you understand the business model, simple enough. Best is you are also in the industry or you have exposure to the company's products. If you are also the long term customer as well, that speaks of some strong point there as well.


Step 2: Prepare enough cash to buy at least 100 of the stocks
- I am mainly deploying this strategy in US listed stock.
- In order to use this strategy, you need to be ready to buy at least 100 of the stocks.
- So you need to ensure that you want to own that stock in the first place.
- Which is why you need to study the business first.
- Therefore, you may need to open a brokerage account that can trade US stocks with low commission. A suggestion will be Interactive Brokers, SaxoBank or TD Ameritrade (Think or Swim).
- Note: While this strategy may be a bit capital intensive, however, the risk is much lower.

Example:

a) Facebook
Share price for 1 Facebook stock is USD175.
So you need to get ready USD175 x 100 = USD17,500.

b) Bank of America
Share price for 1 Bank of America stock is USD22.
So you need to get ready USD22 x 100 = USD2,200

c) XLK ETF
Share price for 1 XLK ETF stock is USD85.
So you need to get ready USD85 x 100 = USD8,500

Having more cash is definitely an advantage.


Step 3: Selling Cash Secured Put

- By using cash secured puts, you are collecting premiums before you even buy the stock.
- Therefore, you lower down the cost of owning the stock.
- Meaning, you are buying the stock at a discount.
- Sell the cash-secured put at OTM.
- Best is to sell during a high volatility period.
- During this period of high VIX because of the Covid-19 situation, it presents a good opportunity to generate more premiums.
- Typically the DTE (date to expiration) is about 30 to 45 days to get a good premium. With the high volatility, you can almost collect similar premiums for 1 to 2 weeks only.
- Select those companies with good volatility only. If you select those good fundamental company with big capitalisation, normally you won't have much issue.


# 3scenarios for Cash Secured Put

1) Share price goes up higher

If this happens, your put options will be even far OTM. No harm for you, as you will be able to keep the premium.

The only caveat is that since the share price has gone up so high, you may not be able to own the share.

However, it is best not to chase the share.

Wait for the share to come to you at the right price.

Anything that goes up too high, thus become overvalue, will eventually need to fall back to the intrinsic value.

Next Action:
Since the share price has gone up high higher, meaning you need to get ready more cash to deploy this cash-secured strategy.


2) Share price is moving sideways.

This is great, meaning, you also get to collect the premium with no capital outlay.

If you own the stock, that means that you are not gaining anything.

But since you are selling the cash secured put, you can start the collect premium as well.

Next Action:
You can repeat this cash-secured strategy again to continue to collect the premium.


3) Share price drops to below the strike price of the put, and now it is ITM (in the money).

You now have 3 options:


a) Let the options expire, and then you will need to buy the share

Since you want to own the stocks anyway, ho harm for you.

You get to buy the stock at a discount because you collected the premium.

You are now a happy shareholder.

And now, you can also start to deploy another options strategy, called selling covered-call options strategy. This strategy will also help you to get premiums as well monthly.

It is like you are an owner of a property, and you are collecting rental from your property.

That's awesome :)

We will talk about this in the coming article.


b) Close the positions for a small loss.

Normally I will not let this happen as I will be monitoring the share price daily.

Will close the position for a maximum 50% loss only based on the premium.

So I will not lose 100% of the debit.

Actually, since the share price drops further, this is good news because we can now buy the good quality stock at an even cheaper price.

That's the benefit of being a Value Investor.

We become happier when the share price is lower at the short term.

Eventually, a good company will rise in value over the long term.

We just needs to be patient.

Having the right mindset is important.


c) Roll the cash-secured put to a lower strike price, and collect premium again.

Rolling will also give you a small loss.

But the premiums collected will offset it.


Example:

Selling Cash Secured Put for Nike Share

Nike share price is currently at USD$86.79 at the close on 9 April 2020.

To sell the cash-secured put, at the strike price of USD$83.50, you can collect premium at USD$113.

If you sell this put on 13 Apr, you will get USD$113 in just 4 day as the DTE is 17 April.

You just need to get ready cash: USD$86.69 x 100 = USD$8,669.

So basically you earn 113/8669 = 1.3% in just 4 days.

If the share price never hit your strike price, you just pocket the premiums.

Then repeat this process again and again weekly.

Sample of Selling Cash Secured Put in Covid-19 Period

Let me share some of the cash-secured put profits that I am able to generate for the past 2 weeks.

I select the following tickers because those are the counters that I have no issue owning.

I have dome the fundamental and it suits my investment objective.

With the recent high volatility, it helps to increase overall premium collection.

Selling cash-secured put is like selling insurance.

You collect the premiums when there is no major disaster happening.

Conclusion

Today's post is a bit long, but if you develop this cash-secured put options strategy properly, it can earn you regular income with low risk.

Thus your stock return can earn up to 20% easily.

The premiums you collected will help you to buy stocks at a discount or even free eventually.

Anyway, please always do your own research and learn the basics of options strategy.

If you do not understand what is options, it can eventually burn your capital as well.

It is a double-edged sword.


Watch some videos below to get a better idea about cash-secured put:

What do you think of this strategy?

Is it too complicated?

Share your comment below.


Happy Investing! 😉


Reference:
https://finance.yahoo.com/quote/NKE/options?p=NKE