Option Investment Strategies

| December 3, 2007 | 0 Comments

Market volatility has almost tripled in just the last few months.
Don’t believe me?  Take a quick look at the Dow Jones Industrial Average.

Since August 1, 2007 we have had 38 trading days in which the market
has moved more than 100 points either up or down.  This means that in 44% of the days the market was open we recorded huge gains and losses.  To make matters worse, I’m only looking at closing prices.  This statistic doesn’t even look at intraday price swings of more than 100 points.

As a point of reference, 2006 was much more stable.  In the 251 trading
days that year, the Dow showed big moves of 100 points or more only 33
times.  We discover with a quick calculation that this volatility appeared in only 13% of the trading days.

Clearly the markets have been a tough place to trade lately.  What
do professional investors do in times like this if they’re long the market?  Many look to protect themselves from huge swings by hedging their investments.

A traditional method of hedging an investment is to buy put options on
stocks that may fall.  Other professional investors sell call options.
The put option makes money if the stock price falls while the call
option provides a cash cushion.

More advanced options traders combine the two strategies.  They sell the call option and use the cash from the sale to buy a put establishing a collar on the stock.  All of these methods provide experienced investors a low cost way to hedge their downside exposure.

These various option strategies provide varying levels of risk and reward.  If you have a portfolio of more than 10 or 15 different stocks, which most investors do, it can be a nightmare trying to determine what options to buy or sell for every position.

There is an easier way however . . .

Some larger funds use options strategies on indexes instead of specific
stocks.  They capture the same benefit from the option strategy and
get the advantage of diversification.  In our research, we uncovered the
Nuveen Equity Premium Opportunity Fund (JSN) which uses advanced
options strategies on Nasdaq 100 and S&P 500 indexes.  The fund simply
focuses on a covered call strategy to generate a steady stream of income for their investors.

Historically this closed end fund has traded at a slight discount or
small premium to its Net Asset Value (NAV).  Today, because of the market volatility, this fund is trading at a 12.8% discount.  They
also pay a monthly dividend from the proceeds of their option strategy.
This yield is now more than 10.8%.

An investor may be able to capture a quick 23.6% by collecting the
monthly dividend and holding the fund until the current trading price
moves back in line with the NAV.  Not too bad if you ask me!


Category: Options Trading

About the Author ()

The Dynamic Wealth Report works with a number of staff writers and guest experts who specialize in everything from penny stocks to ETFs to options trading. These guest analysts post under the 'staff writer' moniker for ease of use.

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