Daily Stock Market Equity and Options Trading Commentary

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Wednesday, June 24, 2009

Don't Let the Bank’s Break You: Hedge Yourself with these 15 Option Strategies

It's Wednesday June 24, 2009 and on my long ride home last night I switched between Sirius channel's 129 and130 or CNBC radio and Bloomberg radio. As I expected, I heard more of the same talks about an overheated market and that we're due for a pull back. One analyst predicted a market correction to 850 on the S&P and the other predicted an even greater pull back to 800 by summer end. However one analyst gave a 50% chance the market would get to 820 and a 50% chance we could continue the rally through summer. Although I cannot comment on this as a professional, I also believe we could see a pull back, but I'm leaning more toward the 850 range on the S&P.

I am devoting this post to the financial sector in particular as we've experienced a greater rally in financials compared to other sectors. Although the financial sector has been beat down the hardest over the past year (as the first chart shows below), if we get this pull back expected, I believe that the financial sector will suffer the most. I used 5 ETF's to demonstrate how much more the financial sector has gained compared to the rest of the market over the past 3 months (as the second chart shows below). The ETF's used in this chart are the: Financial Select Sector SPDR (XLF), Consumer Staples Select Sector SPDR (XLP), Energy Select Sector SPDR (XLE), Technology Select Sector SPDR (XLK), and Industrial Select Sector SPDR (XLI).

(click images to enlarge)

One way to hedge the downside if you own any of these financial companies is to sell the rights to the stock also known as writing covered calls. These are option strategies which I have researched and will give at least 5% downside protection as well as a 5% return by July 18 or August 22 (if the stock happens to rally and meets or exceeds the indicated strike price at July or August expiration). To lean more about options check out my options E-Books.

Below is a table of 15 financial companies, symbol, month of option expiration, strike price, downside protection, % return (if strike price is met at expiration), and the current probability that the options market is factoring in for the given strike price (probability you will sell your shares at expiration).

All data as of pre-market June 24, 2009.

(click to enlarge)

The most attractive buy/write strategies or stocks to write covered calls on in my opinion are: Bank of America (BAC), Keycorp (KEY), and Fifth Third (FITB), as they are all above average (based on these 15 stocks) on % protection, % return, and probability of expiring in the money. To compare these 15 to each other I had to compute the average daily protection for each strategy and the average daily % return (if called out). As you may already know writing stocks out for the July expiration is more attractive and will yield higher protection as well as return (25 less days in the contract until expiration).

Below are three printable versions of this table of stocks ranked from least to greatest in all 3 categories (% protection, % return, and % probability of expiring in the money). The third table is ranked by current probability of expiring in the money, but also has the fields the stocks are above average, highlighted in green (starting with downside protection, if above average after that will not be highlighted, etc...).

(click to enlarge and print)

If you're more bullish/bearish you’ll want to adjust the strike price and expiration accordingly. If you’re more bearish write deeper in the money calls, you will not return as much if you get called out, but if you do, and the overall market is down you’ll most likely outperform the market.

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