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An Options Strategy That Helps Returns Fly High

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An Options Strategy That Helps Returns Fly High www.barrons.com (C) 2016, DOW JONES & COMPANY, INC. ALL RIGHTS RESERVED SATURDAY, JULY 30, 2016 An Options Strategy That Helps Returns Fly High BY STEPHEN J. SOLAKA Income-oriented investors face strategies. To implement a condor, 2 and purchase the SPY 195 put with serious challenges. investors sell out-of-the-money calls the same expiration date. Interest rates on bank deposits and puts, and hedge their risk by The trade would generate a are near zero, and effectively below buying calls and puts that are even $1.10 credit, which means the options zero after factoring in inflation. further out of the money. market is paying investors to assume Buying bonds to generate cash flow is By combining a put and call the risk that SPY remains between not much better, especially for spread, the strategy can generate 206 and 222. Should that prove investors in the growing number of significant income. After all, you get accurate, a $1 million position would nations with negative bond yields, paid for selling calls or puts that are, generate a $5,000, or 0.50%, return in such as Japan and Switzerland. say, 5% above and below the market. just over a month. If SPY moves Many investors have responded More distant puts and calls can often sharply higher or lower, the maximum by purchasing stocks and hoping (the be bought for less money, which loss on either spread is the difference most dangerous word in markets) that means investors can pocket the between the short and long strike, prices will keep rising, even though difference, effectively getting the minus the total premium collected for valuations seem stretched—or at least options market to help pay them to the trade. that stocks won’t fall, or get stuck in a implement their condors. Investors uncomfortable with trading range. The strategy’s key risk is that so many moving parts can generate But investors can enhance their the underlying security turns out to be income or enhance returns by simply portfolios, diversify returns, and more volatile than anticipated, and selling puts on the broad market generate income with a few well- shoots through the short strikes. While indexes or on stocks they want to placed puts and calls. this sounds bad, the risk is defined. own. A Chicago Board Options We are seeing sophisticated How? All short options are paired Exchange study found that selling investors increasingly focus on with long options. Ideally, the puts on the S&P 500 from June 1986 selling, or “writing,” short-term out- underlying security remains between to December 2015 returned 10.13% of-the-money call-and-put spreads on the two short strikes and investors per annum, outpacing the market’s equity indexes. The strategy, known collect the entire premium. 9.85% return with one-third less as the “iron condor,” has an In my experience, the condor’s volatility. impressive history. The Chicago return depends less on the associated The bottom line: Less risk and Board Options Exchange S&P 500 stock’s direction than it does on how better returns are something all Iron Condor index returned 10.40% in quickly the security moves. investors should take a look at. And 2015, compared with the Standard & THE FOLLOWING TRADE prudent options strategies can provide Poor’s 500 index’s 1.38%. In the illustrates how the strategy works: them. volatile 2008 market, the condor With the SPDR S&P 500 STEPHEN J. SOLAKA is a index fell 3.99%, as the S&P 500 sank exchange-traded fund (ticker: SPY) managing partner at the Belmont by 37%. trading at 216, investors could sell the Capital Group in Los Angeles. THE IRON CONDOR’S SPY 222 call that expires Sept. 2 and E-mail: [email protected] seeming complexity often frightens buy the SPY 227 call with the same Like Barron’s on Facebook investors. But the strategy simply expiration date. Follow Barron’s on Twitter entails selling a put spread and call At the same time, they could spread, two very common trading sell the SPY 206 put that expires Sept. THE PUBLISHER'S SALE OF THIS REPRINT DOES NOT CONSTITUTE OR IMPLY ANY ENDORSEMENT OR SPONSORSHIP OF ANY PRODUCT, SERVICE, COMPANY OR ORGANIZATION CUSTOM REPRINTS (609) 520-4331 P.O. BOX 300 PRINCETON, NJ 08543-0300. DO NOT EDIT OR ALTER REPRINTS, REPRODUCTIONS NOT PERMITTED.
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