From an investor’s point of view, there are a couple of things to avoid. 1) taxes and 2) broker costs. This is where options come into play very handy. If you live in Belgium, you’re probably walking like the Hunchback of Notre-Dame due to all the heavy taxes onto our shoulders. Enter: options.
A normal transaction (<€2500) of stocks (turbo’s as well) would cost me €7,25 broker fees for the Brussels Stock Exchange and slightly more for other exchanges (€10-something) + government tax of 0,27% of the invested amount. So let’s assume we buy 100 stocks at €20 each, this results in €2000 accompanied by €12,65 in costs. Now the price goes up to €25 and we decide to sell our position. This means we have to pay €14 (higher taxes). Eventually we paid €26,65 in broker fees and government taxes, reducing our total profit by more than 5% of the total amount!
Now, if we would have done the same by putting up an option construction, this would cost €2,45/contract. Let’s assume a buy and close so €4,90 in total. This makes a difference of €21,75 or almost a fivefold! Options are free of taxes. And now we are only calculating with relatively small amounts of €2,000 so imagine what €50,000 would be. I’ll skip the calculations, but a difference of around €300! These €300 can get you back and forth to Miami, just to give an idea.
Check the picture below to see how options work:
This is how it works in a nutshell. Now there are a lot of different option strategies of which quite a few are explained in this link: Investopedia Option Guide
It’d be double work to type this all over again. I will just review the option strategies that I prefer using. Note that an option implies 100 stocks!
- Covered Call: Are you thinking about selling an expensive stock when it hits a particular price? Sell a covered call option. Let’s say you would want to sell Wal-Mart at $100 with deadline in June. This will give you an extra $4,50 a share so $450 in total. What’s your risk? If Wal-Mart goes higher than $104,5 then you would have less profits, however this is not true because you would already have sold them at $100. So in my opinion you’re only fucked when the price dips under $95,5 but then you can repeat the construction and still collect dividends in the meantime.
- Naked puts: Here is the advantage that you can work on margin, you don’t actually need the cash. But beware!!! Know what you are doing, things can get bloody working on margin if it goes the bad way. Of course you don’t have to work on margin, but it can boost your results significantly. I do it, but not excessively. Let’s say you want to buy AB Inbev at price €95 but you don’t have the cash to buy 100 stocks. Sept18 puts @ €95 give an option premium of €8 so basically you would buy them at €87 if exercised. This gives some downside protection and you can profit from the movement of a 100 stocks. So as long as the stocks trades above €87, you’re making money. If the stock would dip below that point, you can roll the option (buy it back and sell it again at a lower strike).
- Sell both a call and put: There’s probably a name for this construction, but I can’t find it. Let’s say you have your eyes on a stock that’s not particularly expensive nor cheap. In my opinion, Walt Disney is a good example. Trading today at around $110, I’ll use this price. Use different strikes, but same deadline. What I would do in these circumstances: sell 1 call @ strike 125, deadline sept18 for $2,70 and sell 1 put @ strike $97,5 deadline sept18 for $2,90. This results in a $560 premium. You make a profit if at deadline the stock is moving in between the $91,9 – $130,6 range. Note that this is quite a good spread for the range. The risk for this construction is that the stock suddenly makes a huge move. Think mergers, very bad results, fraud… So choose wisely about which stock you pick as underlying asset. In normal conditions, the stock price won’t go up or down that fast so the time factor in option price will decrease which means profit even if the stock price stays the same!
These are my most preferred tactics.
Options can be very profitable and have certain cost advantages but beware when working on margin and always know what you are doing.
Do you have certain profitable option strategies?