Most investors are looking for a way to either increase their returns or reduce their risk. Though
options have the ability to do both these things, many people don’t understand what options are or how to use them. They also think that options are too difficult and complex to learn, though once learned, the endless supply of options combinations tends to be a blessing, not a curse. People who don’t understand options are missing out on the many strategies that can enhance returns and lessen risk.
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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.
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This week, we review what are known as the put/call parity rules. If you know one rule - and you remember your high school algebra - you can quickly master all the rules. Mastery of these rules gives you a lot more flexibility when planning your option strategies.
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Often, when markets are panicked, lower strike short-term premiums are overpriced, while longer-term higher strike premiums are relatively cheap. The diagonal backspread offers you a way to take advantage of such a situation if you think that the stocks are likely to recover.
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This spread, which can often be established with little or no outlay of cash, and can offer you a way to participate in a rapidly rising stock with little downside risk.
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