SMSF Investment StrategiesSharing Simple Strategies for Self Managed Super Funds
Increasing yield through selling options
Volatility is the only thing we can be certain of today. The crazy price action in the past 3 months is enough to make any prudent investor want to stay away from the stock market. However, if we take a closer look at the market action, we can still find some safe investment strategies using stocks and options. Below is a table showing the gains and losses in ASX 200 sectors in the last 3 months:
The first thing you notice is that not all sectors are equally volatile. The defensive sectors (shaded in green) are hardly affected by the volatility. Some stocks in these sectors pay a good amount of fully franked dividends as well. Buying a defensive sector stock like Telstra seems like a no brainer. At the price of $3.28 per share it still has a dividend yield of 8.5% or 12% if you include franking credits, which is twice what we can get from cash. For those of us who know options, this yield can be further improved by selling covered calls.
Another observation I have made from the above table is that big falls tend to be followed by sharp rallies in the volatile sectors (shaded in blue). Another strategy that I am currently pursuing is selling out of the money (OTM) put options on fundamentally good stocks in volatile sectors after a major correction. I will walk through an example of such a trade using BHP, which I think most would agree is a fundamentally good stock in the volatile materials sector. By looking at the chart of BHP (shown below), we can see that there is strong support for BHP at $34 i.e. BHP tends to rally whenever it falls to $34.
When the price of BHP comes close to this support level, I would look at selling put options at that strike price. At today’s price of $35.76, I can collect a premium of $1.12 for selling a BHP put option at the strike price of $34 which expires on 23 February 2012 as shown below.
Source: E*TRADE
The most likely outcome in February 2012 is that BHP will be trading above $34 by that time and my put options will expire worthless and I get to keep the $1.12 premium. This is a 3% return in 3 months or an annualised return of 12% which is a similar return to what I can get from Telstra dividends. Unlike doing covered calls, I do not need to own stocks to sell puts. The puts are secured by cash which I can keep in a high interest bearing account while waiting for my puts to expire. Based on the current Usaver interest rate, the bank interest can add another 6% return to this strategy. Selling puts does have risks and the risk is that I will have to buy BHP stocks at $34 if the buyers of my put options choose to exercise their right to sell their shares at that price. I need to make sure I have the cash to buy the BHP shares if that happens. For me buying BHP shares at a cost of $32.88 ($34 for the shares less the $1.12 option premium collected) is a risk I am prepared to take.
Selling OTM puts is my preferred options strategy for stocks that do not pay much dividends. There is not much point in holding these stocks in bearish / sideways markets when there is little chance of capital appreciation. I wholeheartedly agree with Aaron Gurwitz, the chief investment officer of Barclays Wealth that selling covered calls on stocks you own and selling puts on stocks you don’t mind owning are good strategies for this “directionless volatile” market.
As this may be my last post for the year, I would like to wish all my readers a Merry Christmas and a Happy 2012!
Christina McDonald
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