Although the market is a leading indicator for the economy, in recent times the two seem to be very disconnected. The market has got ahead of itself on better than expected economic data and company earnings; keyword is expected. Measure earnings for the previous quarter over the same period one or two years ago... When earnings return to those levels, perhaps a real recovery will be in the works. Of course there will be companies that grew, but I am referring to the majority.
Three major reasons I believe a sell off is in the works:
- Simple Profit Taking - What goes up must come down; can you imagine the market if profits were never taken?
- Analyst Revisions - Just as analysts upgrade stocks when they are undervalued, it is also their job to downgrade stocks when they are overvalued... I imagine you have formed some opinions of some overvalued stocks.
- Earnings Season is Coming to an End - Right now there seems to be an overwhelming amount of good news flooding the market. But I believe it is only a matter of time before the bad news outweighs the good news (or better than expected) once again, and a correction will occur. What reason would the market rally with overwhelming bad news?
With my reasons outlined above as to why I believe a correction will occur, I have been getting very conservative. I have my portfolio geared for roughly a 10% correction on the S&P 500. Many people choose to purchase put options as protection including myself, but most of the time I will use the most basic form of option out there for protection; a covered call.
Although I am not anticipating the market to continue rallying, I will also note that the rally easily could, as money continues to pour into the market from the sidelines. As I stated earlier, I've been selling covered calls on many of my stocks to protect my positions. Even though I'm young and can risk a lot, I believe it is better to be safe than sorry and if I get called out and have to sit in cash, I'll take it. Selling covered calls is a great way to create income off the shares in your portfolio, as well as allow for an additional gain. Selling covered calls is ideal for this type of speculation, which is why I have decided to outline 25 ideas in this article. To learn more about this strategy, and stock options in general click here. I will use the 25 largest stocks (by market cap) in the S&P 500 for my analysis. For those who can risk more, I have also included a list of 10 higher beta stocks.
Monday kicks off the week for August options expiration, most of the stocks outlined in this article will yield very small premiums for the August expiration, so I have used the options expiration for the month of September on all the stocks. For those which currently have the October contract available I have also noted it, the October contract will be available on all stocks as of Monday August 24, 2009. All stocks are rounded and written for the closest possible strike price.
To understand the table, I will give a detailed example of Apple (NASDAQ:AAPL) below.
Sell the Apple in the money September 165 strike call option. The premium received from the call option would give a downside protection of 4.18%. If the stock is assigned at options expiration on September 19, 2009 the total return from this position (assumes the buy/write option strategy was used) would be 3.11% in 35 days.
A more bullish approach would be to write out the Apple 170 Call option. This approach would protect to the downside 2.71%, and if the stock is assigned at expiration it would return 4.65%.
The September options expiration is 35 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 etc... Writing stocks out before the weekend will take some premium away from these option contracts as well, which is another positive to being the seller of these options.
All data as of market close Friday August 14, 2009.
| Company | Ticker | Strike | Return % | Protection % |
| Exxon Mobil Corporation | NYSE:XOM | 70 | 4.38 | 1.76 |
| Microsoft Corporation | NASDAQ:MSFT | 24 | 3.76 | 2.49 |
| Wal-Mart Stores, Inc. | NYSE:WMT | 52.5 | 2.99 | 1.62 |
| Johnson & Johnson | NYSE:JNJ | 60 | 1.70 | 1.83 |
| The Procter & Gamble Company | NYSE:PG | 52.5 | 2.67 | 2.43 |
| International Business Machines Corp. | NYSE:IBM | 120 | 3.46 | 2.25 |
| AT&T Inc. | NYSE:T | 25 | 2.08 | 3.85 |
| Apple Inc. | NASDAQ:AAPL | 165 | 3.11 | 4.18 |
| JPMorgan Chase & Co. | NYSE:JPM | 42.5 | 5.02 | 4.90 |
| Google Inc. | NASDAQ:GOOG | 460 | 2.79 | 2.79 |
| Chevron Corporation | NYSE:CVX | 70 | 3.96 | 1.97 |
| General Electric Company | NYSE:GE | 14 | 5.10 | 4.53 |
| Cisco Systems, Inc. | NASDAQ:CSCO | 21 | 2.82 | 4.27 |
| Bank of America Corporation | NYSE:BAC | 17 | 5.35 | 7.59 |
| Wells Fargo & Company | NYSE:WFC | 28 | 6.09 | 5.12 |
| The Coca-Cola Company | NYSE:KO | 47.5 | 1.40 | 3.40 |
| Oracle Corporation | NASDAQ:ORCL | 22 | 3.96 | 3.78 |
| Intel Corporation | NASDAQ:INTC | 19 | 4.37 | 3.14 |
| Pfizer Inc. | NYSE:PFE | 16 | 4.19 | 2.73 |
| Hewlett-Packard Company | NYSE:HPQ | 44 | 3.88 | 4.08 |
| Philip Morris International Inc. | NYSE:PM | 47 | 3.39 | 2.57 |
| Verizon Communications Inc. | NYSE:VZ | 31 | 2.77 | 3.02 |
| PepsiCo, Inc. | NYSE:PEP | 57.5 | 3.25 | 1.59 |
| Goldman Sachs Group, Inc. | NYSE:GS | 165 | 4.84 | 3.44 |
| QUALCOMM, Inc. | NASDAQ:QCOM | 46 | 3.21 | 3.53 |
The 10 higher beta stocks are listed below, as you can see the return and protection % are higher on average. This is because they are much more volatile and volatility plays a major role in pricing the options.
| Las Vegas Sands Corp. | NYSE:LVS | 14 | 13.59 | 8.48 |
| MGM MIRAGE | NYSE:MGM | 9 | 10.96 | 10.29 |
| Teck Resources Limited (USA) | NYSE:TCK | 26 | 7.59 | 8.92 |
| Genworth Financial, Inc. | NYSE:GNW | 9 | 15.34 | 6.64 |
| American International Group, Inc. | NYSE:AIG | 24 | 12.35 | 13.87 |
| Wynn Resorts, Limited | NASDAQ:WYNN | 55 | 6.56 | 10.32 |
| Barclays PLC (ADR) | NYSE:BCS | 25 | 7.98 | 4.03 |
| Citigroup Inc. | NYSE:C | 4 | 8.66 | 9.65 |
| Ivanhoe Mines Ltd. (USA) | NYSE:IVN | 7.5 | 6.67 | 20.37 |
| Palm, Inc. | NASDAQ:PALM | 14 | 9.38 | 9.94 |
For those which currently have the October options contracts available you can see the calculations below. I prefer staying as short as possible, so I wouldn't consider the October options expiration with more than 10 days until expiration for the September contracts.
| Company | Ticker | Strike | Return % | Protection % |
| Exxon Mobil Corporation | XOM | 70 | 5.63 | 2.93 |
| Microsoft Corporation | MSFT | 24 | 5.19 | 3.88 |
| Johnson & Johnson | JNJ | 60 | 2.70 | 2.83 |
| The Procter & Gamble Company | PG | 52.5 | 3.78 | 3.52 |
| International Business Machines Corp. | IBM | 120 | 4.92 | 3.67 |
| AT&T Inc. | T | 25 | 3.14 | 5.00 |
| Apple Inc. | AAPL | 165 | 4.79 | 5.92 |
| Cisco Systems, Inc. | CSCO | 21 | 4.27 | 5.81 |
| Wells Fargo & Company | WFC | 28 | 8.84 | 7.79 |
| Intel Corporation | INTC | 19 | 6.45 | 5.16 |
| Verizon Communications Inc. | VZ | 31 | 3.70 | 3.97 |
| PepsiCo, Inc. | PEP | 57.5 | 4.40 | 2.70 |
| Goldman Sachs Group, Inc. | GS | 165 | 6.93 | 5.45 |
| QUALCOMM, Inc. | QCOM | 46 | 4.83 | 5.17 |
To better understand options in general, including this strategy, these percentage calculations, and other option strategies click here. As an owner of Bank of America, Citigroup, and Goldman Sachs shares, I've written them out for a variety of strikes for August expiration and will be writing them again for the September options expiration, as the volatility of the underlying stock gives a very nice premium, even on out of the money options and a month until expiration.
I never write all of my shares out at the same time. If we get a pull back, market volatility should increase, causing call options to trade for higher premiums, 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).
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.
Instead of spending additional money on put protection, this strategy allows income to flow to your portfolio providing protection on the position.
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