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.

Company	Exchange	Ticker	Strike	Premium	Return%	Protection %
Exxon Mobil Corporation	NYSE	XOM	70	1.75	1.46	2.47
Microsoft Corporation	NASDAQ	MSFT	23	1.11	1.26	4.66
Wal-Mart Stores, Inc.	NYSE	WMT	47.5	2.64	0.32	5.28
Johnson & Johnson	NYSE	JNJ	60	2.22	0.70	3.59
The Procter & Gamble Company	NYSE	PG	55	2.1	1.55	3.73
International Business Machines Corp.	NYSE	IBM	115	4	0.97	3.39
AT&T Inc.	NYSE	T	26	0.76	1.59	2.89
Apple Inc.	NASDAQ	AAPL	160	6.05	2.00	3.72
JPMorgan Chase & Co.	NYSE	JPM	37	2.14	1.74	5.56
Google Inc.	NASDAQ	GOOG	430	21.3	1.27	4.78
Chevron Corporation	NYSE	CVX	65	3.45	1.11	5.10
General Electric Company	NYSE	GE	12	1.28	1.30	9.76
Cisco Systems, Inc.	NASDAQ	CSCO	21	1.29	1.41	5.87
Bank of America Corporation	NYSE	BAC	13	1.21	1.72	8.66
Wells Fargo & Company	NYSE	WFC	24	1.4	2.13	5.63
The Coca-Cola Company	NYSE	KO	47.5	2.4	0.46	4.83
Oracle Corporation	NASDAQ	ORCL	21	1.33	0.86	6.01
Intel Corporation	NASDAQ	INTC	19	0.66	1.71	3.41
Pfizer Inc.	NYSE	PFE	15	0.99	0.31	6.21
Hewlett-Packard Company	NYSE	HPQ	42.5	1.55	3.14	3.63
Philip Morris International Inc.	NYSE	PM	46	1.55	1.56	3.31
Verizon Communications Inc.	NYSE	VZ	31	1.53	0.68	4.74
PepsiCo, Inc.	NYSE	PEP	55	2.17	1.01	3.83
Goldman Sachs Group, Inc.	NYSE	GS	160	5.95	2.17	3.66
QUALCOMM, Inc.	NASDAQ	QCOM	45	2.16	1.38	4.64
Abbott Laboratories	NYSE	ABT	44	2.15	0.98	4.70
ConocoPhillips	NYSE	COP	42	1.97	1.81	4.56
Schlumberger Limited	NYSE	SLB	50	4.25	1.53	7.95
Merck & Co., Inc.	NYSE	MRK	29	1.55	2.04	5.18
Amgen, Inc.	NASDAQ	AMGN	60	4.2	1.73	6.66
Wyeth	NYSE	WYE	45	2.03	0.73	4.35
McDonald's Corporation	NYSE	MCD	55	1.4	1.46	2.52
Occidental Petroleum Corporation	NYSE	OXY	70	2.7	2.99	3.82
United Parcel Service, Inc.	NYSE	UPS	55	0.73	3.94	1.36
CVS Caremark Corporation	NYSE	CVS	32.5	1.7	1.82	5.06
United Technologies Corporation	NYSE	UTX	55	0.98	3.23	1.81
The Walt Disney Company	NYSE	DIS	25	1.78	2.14	6.79
3M Company	NYSE	MMM	70	1.5	2.29	2.15
Monsanto Company	NYSE	MON	85	2.55	3.70	3.02
Gilead Sciences, Inc.	NASDAQ	GILD	49	1.55	1.96	3.13
The Home Depot, Inc.	NYSE	HD	25	1.37	2.01	5.30
Schering-Plough Corporation	NYSE	SGP	26	0.93	1.62	3.51
Comcast Corporation	NASDAQ	CMCSA	15	0.67	4.33	4.46
Bristol Myers Squibb Co.	NYSE	BMY	21	0.9	1.58	4.17
Kraft Foods Inc.	NYSE	KFT	28	1.15	2.03	4.03
Eli Lilly & Co.	NYSE	LLY	35	0.63	1.65	1.80
Medtronic, Inc.	NYSE	MDT	35	1.08	2.04	3.05
U.S. Bancorp	NYSE	USB	20	0.92	2.15	4.49
Colgate-Palmolive Company	NYSE	CL	70	2.7	1.21	3.76
Morgan Stanley	NYSE	MS	28	1.22	3.03	4.30

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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