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Daily Stock Market Equity and Options Trading Commentary

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Thursday, July 30, 2009

How to Profit & Protect the S&P 50 with Options in this Overbought Market

Thursday was another great day for the bulls on Wall Street, and another great opportunity to get short for me, as I believe this market is well overbought on the short term. The market sold off a bit going into the close, my guess is because some were taking profits before the GDP numbers. The stock market major indices are up huge since July 1, 2009; Dow Jones Industrial Average up 8.38%, NASDAQ up 8.13%, and the S&P 500 up 7.33% (click chart to enlarge).

However to reiterate myself from a previous blog post on OptionMaestro.com, this market could continue the rally with better than expected earnings, and a "less worse" economic outlook. There is still a ton of money on the sidelines gaining almost nothing, that could be put to work in the market. However I don't think a 5% short term correction is out of the picture. I am being extremely cautious committing new capital to the market at these levels, but one strategy I am using to get into this market is the Buy/Write option strategy. The buy/write option strategy allows me to get into the stocks for less than current levels, with provide me with a positive returns if the market continues to rally, and give me protection is the market sells off from the current level. In this post I will outline the top 50 companies (by market cap) in the S&P 500 index, and will provide a buy/write option strategy for each. Therefore, to understand this post you'll need some knowledge of stock options. To learn more about stock options check out my blog or book here.

For this analysis I used the S&P 500 list of stocks spreadsheet I created, to generate the top 50 stocks by market cap with the click of a button. To download this spreadsheet click here.

All data as of market close Thursday July 30, 2009.

The stocks are in order from greatest to least market cap. The first stock in the table below is Exxon Mobil (XOM) to understand how to read the table I'll give a worded example using Exxon Mobil. The example assumes the stock was being purchased and immediately written out for the August options expiration.

Purchase Exxon Mobil (XOM) stock, and sell the in the money August 70 strike call option. The premium received from the call option would give a downside protection of 2.47%. If the stock is assigned at options expiration on August 22, 2009 the total return from this position would be 1.46%. The August options expiration is 22 calendar days away, so it may be best to monitor the position and buy back the call option on weakness of the underlying stock, if the stock rallies after it is purchased back, write it back out for a higher premium.

CompanyExchangeTickerStrikePremiumReturn%Protection %
Exxon Mobil Corporation NYSE XOM 701.751.462.47
Microsoft Corporation NASDAQ MSFT 231.111.264.66
Wal-Mart Stores, Inc. NYSE WMT 47.52.640.325.28
Johnson & Johnson NYSE JNJ 602.220.703.59
The Procter & Gamble Company NYSE PG 552.11.553.73
International Business Machines Corp. NYSE IBM 11540.973.39
AT&T Inc. NYSE T 260.761.592.89
Apple Inc. NASDAQ AAPL 1606.052.003.72
JPMorgan Chase & Co. NYSE JPM 372.141.745.56
Google Inc. NASDAQ GOOG 43021.31.274.78
Chevron Corporation NYSE CVX 653.451.115.10
General Electric Company NYSE GE 121.281.309.76
Cisco Systems, Inc. NASDAQ CSCO 211.291.415.87
Bank of America Corporation NYSE BAC 131.211.728.66
Wells Fargo & Company NYSE WFC 241.42.135.63
The Coca-Cola Company NYSE KO 47.52.40.464.83
Oracle Corporation NASDAQ ORCL 211.330.866.01
Intel Corporation NASDAQ INTC 190.661.713.41
Pfizer Inc. NYSE PFE 150.990.316.21
Hewlett-Packard Company NYSE HPQ 42.51.553.143.63
Philip Morris International Inc. NYSE PM 461.551.563.31
Verizon Communications Inc. NYSE VZ 311.530.684.74
PepsiCo, Inc. NYSE PEP 552.171.013.83
Goldman Sachs Group, Inc. NYSE GS 1605.952.173.66
QUALCOMM, Inc. NASDAQ QCOM 452.161.384.64
Abbott Laboratories NYSE ABT 442.150.984.70
ConocoPhillips NYSE COP 421.971.814.56
Schlumberger Limited NYSE SLB 504.251.537.95
Merck & Co., Inc. NYSE MRK 291.552.045.18
Amgen, Inc. NASDAQ AMGN 604.21.736.66
Wyeth NYSE WYE 452.030.734.35
McDonald's Corporation NYSE MCD 551.41.462.52
Occidental Petroleum Corporation NYSE OXY 702.72.993.82
United Parcel Service, Inc. NYSE UPS 550.733.941.36
CVS Caremark Corporation NYSE CVS 32.51.71.825.06
United Technologies Corporation NYSE UTX 550.983.231.81
The Walt Disney Company NYSE DIS 251.782.146.79
3M Company NYSE MMM 701.52.292.15
Monsanto Company NYSE MON 852.553.703.02
Gilead Sciences, Inc. NASDAQ GILD 491.551.963.13
The Home Depot, Inc. NYSE HD 251.372.015.30
Schering-Plough Corporation NYSE SGP 260.931.623.51
Comcast Corporation NASDAQ CMCSA 150.674.334.46
Bristol Myers Squibb Co. NYSE BMY 210.91.584.17
Kraft Foods Inc. NYSE KFT 281.152.034.03
Eli Lilly & Co. NYSE LLY 350.631.651.80
Medtronic, Inc. NYSE MDT 351.082.043.05
U.S. Bancorp NYSE USB 200.922.154.49
Colgate-Palmolive Company NYSE CL 702.71.213.76
Morgan Stanley NYSE MS 281.223.034.30

As the Volatility index is creeping back up, call option premiums should increase in value overall, protecting and giving an even higher return. I use this strategy to write my shares out on strength, and purchase them back on weakness (if I am profitable). For example: using this strategy has allowed me to cost average my position on Caterpillar (NYSE:CAT) down to $4.88 a share. Patience is key to succeed with this strategy. If the stock gets called out, and you miss the upside, the position is still profitable and you can always do it again for the next options expiration. If the stock gets hammered and you're down on the position, this strategy will keep you in the game and allow you to cost average the shares down month after month.

All of these options expire on August 22; therefore the last trading day is Friday, August 21, 2009.

These are just examples and are not recommendations to buy or sell any security; if you're more bullish/bearish, you’ll want to adjust the strike price and expiration accordingly.

This strategy will give protection if the market sells off, as well as provide a return if the market continues to rally. If the stock is not assigned, this strategy is a great way to create additional income for your portfolio. The reason option volumes have surged in the last 5 years is because they are a great way to hedge your portfolio as well as create income off of your shares (see chart here). Keep in mind when using this strategy it is essential that broker commissions are low enough to profit from the position.

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1 comments:

Rocky said...

Interesting text. You have a nice blog. Keep it up!

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