Over the years, Value Line Options’ covered calls have beaten the major stock indexes by wide margins.  In screening for attractively priced covered calls, we have specified that we are looking for calls that are overpriced (according to the Value Line Options model), and as covered calls, offer premium income in excess of 20% per annum.  We have also specified that the stock could fall as much as 2% at expiration and the investor would still break even. Narrowing our search down to stocks with superior six to twelve month appreciation potential, we came up with a short list of covered calls.

LEAPS are longer-term puts or calls with expirations of between nine months and two and a half years.  Put LEAPS can be attractive as portfolio hedges because they lose time premium at a much slower rate than do shorter-term puts. Selecting the most underpriced LEAPS per underlying stock, our screening came up with 24 LEAPS on 14 stocks.

You create a cash-covered put when you write a put and maintain enough cash in your brokerage account to cover the entire risk of holding the position.  Readers of our Weekly Strategist Reports will know that cash covered puts and covered calls are what are called equivalent positions.  That is, for the same stock, strike and expiration, these positions require essentially the same amount of capital and offer very similar risks and rewards. Here we have screened for attractively priced (i.e. overpriced) puts on stocks with above average appreciation potential that also meet the following criteria; minimum per annum yield of 20%, minimum protection (breakeven) of 6%, and a bid/ask spread no wider than 20%. Limiting our search to one put option per stock (the best scoring), our screener came up with 29 candidates, among them:

If you write a put on a stock and keep enough cash in your account to cover your maximum risk, you create a position known a “cash-covered put write.” There is no margin requirement on the cash-covered put and the position’s gain and loss profile is almost identical to the corresponding covered call (same stock, strike, and expiration). In this week’s report, using put and call examples from Bio-Rad Labs (BIO), we show you how these two strategies are basically equivalent.  We also discuss when cash-covered puts might be preferable to covered calls.

If you are already familiar with options (what they are, what gives them value, the terms that describe them and how they are traded), you can probably skip this chapter. However, if you are uncertain about some of the terms or concepts, this chapter will probably answer your questions. We start with some basic definitions.

Options have their place in an investor’s overall toolkit.  When used judiciously, options can help increase the income generated by a portfolio and provide downside protection to wary investors.  Two funds to examine that use options are Van Kampen Equity Premium Income Fund (VEPAX) and Gateway Fund (GATEX).  Although the news in recent years has highlighted the risks of certain investment strategies, such as options, the headlines shouldn’t dissuade investors from learning more. 

This is definitely a market in which you need to be hedged. The S&P 500 and the Dow are down about 11% over the past month and only about 2% above earlier January lows. On the other hand, some stocks are doing better than others. Value Line’s rank 1 common stocks are down only about 3.5% as investors are tentatively looking for growth potential. In what may be a “stock picker’s” market, holding good stocks and protecting them with puts may be the way to go. In this week’s report, we cover in some detail how to hedge stocks you own with puts. Even when markets are volatile (as they are now), you can tailor your put insurance to suit your expectations and your tolerance for risk.