CONSERVATIVE OPTIONS STRATEGIES.

My Most Successful Investment Strategy Involves the Use of Options. I have avoided talking about options strategies on this blog because I wasn't sure I could explain it adequately. Still, I would be negligent if I didn't share with you something that has worked so well for me. I started this strategy at the end of 2003 and, for the three years ending in 2006, I have earned just under 20% per year. Granted, I spent a fair amount of time monitoring this portfolio but the time spent contributed to my knowledge of the market place. I could probably have done this in less time but I very much enjoyed exploring this strategy. The thing I like the most about my strategy is that I believe that, contrary to popular opinion, it is less risky than buy and hold strategies. So what's not to like? Above market returns and below market risk. Rather than give you a bunch of definitions, I will try to explain the terminology as I go along.

Selling Put Options Is Probably the Most Simple Strategy I Use. When I sell a put option, I give the purchaser of this option the right (but not the obligation) to sell me a certain number of shares of a particular stock at a certain price for a certain time period. Here's an actual example: On Friday, January 19, I sold an option that allows the buyer to sell me 1000 shares of Qual Comm stock for $37.50. As of that date the stock was selling for $38.87. Since the current stock price is above the price at which I have to buy the stock (strike price), this option is an out-the-money (OTM) option. If I had sold a put option with a strike price of $40, that would have been an in-the-money (ITM) option. The purchaser paid me $800 for the privilege of being able to sell me this stock between now and February 16 (27 days from now). If the stock rises or stays the same, I get to keep the $800. If the stock drops to $37.49 or lower, I will have to buy the stock for $37.50. Since I got 80 cents a share in premium, my break even point is $36.70. The buyer is betting that the stock drops below that level and I am betting that it doesn't. The reason that most investors will not make this trade is that I am risking $36,700 for a maximum gain of $800. While this is true, it is an extreme case assuming the stock goes to zero. If I buy the stock at today's price of $38.87, I stand to lose $2,170 more than with the option trade. In addition, I have to have $38.870 in cash to buy the stock. With the option trade, I get $800 in my account right away. Granted, I better have a plan as to how I'm going to get the cash to buy that stock if I have to. In fact, the brokerage house will demand that I have enough cash or borrowing power in my account to perform if necessary.

I AM Bullish On Qual Comm Stock. If I weren't, I wouldn't be making that trade. I view it as putting in an order to buy the stock at $36.70. I am willing to own it at that price. I don't want to pay the going market rate of #38.87. If I don't end up owning the stock, I get to keep the $800 premium I received. This is what happens about 80% of the time. Once you establish a position like this, you don't just walk away and forget it. Managing the position is probably more important than establishing it. There are several things you can do to maximize your gains or minimize your losses in this instance. During the next 27 days, I will make several posts letting you know where I stand on this trade, what my options are and how things turn out. Hopefully, this will be educational and interesting to you.

Do Not Try This At Home. Like the commercials that show the crazy driver doing car stunts, I would caution you not to try this strategy based on what you read here. I have made bad trades that cost me a considerable amount of money. If you implement a similar strategy, I guarantee that you will too. Hopefully my Qual Comm trade won't be one of them causing me considerable embarrassment among my loyal readers.