One of the amazing points about options is the flexibility they bring to trading. But is it possible to develop a strategy that holds risk down to a nice low level, while increasing profits?
Yes.
In fact, there are many conservative trades possible with options. A definition of “conservative” that I use is:
Conservative: a strategy or series of strategies that reduce risk while increasing income.
There are numerous possibilities, but one that is especially intriguing is the ratio write. In this strategy, you write more calls than you cover. In the traditional covered calls, you sell one call per 100 shares. In the ratio write, you exceed this. For example, if you own 300 shares and you sell four calls, it sets up a 4:3 ratio write.
For example, on March 21, 2012 Adobe Systems ADBE closed at $33.56. If you had bought 300 shares three months ago when the stock was as low as $27.40, you have a six-point appreciation in the position. Rather than taking profits, you decide to write a 4:3 ratio write. You sell four of the May 34 contracts at 1.12, collecting $448 before trading costs. That discounts your current position to $32.07 per share:
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- 4 calls premium income = $448
- Net basis = $9,620
- $9,620 ÷ 3 = $3,206.67
- two 34 calls @ 1.12 = $224
- two 35 calls @ 0.73 = $146
- total income = $370
- Stock $3,356 x 300 = $10,068
- 4 calls premium income = $370
- Net basis = $9,698
- $9,698 ÷ 3 = $3,232.67
- $370 ÷ $10,068 = 3.7%
- ( 3.7% ÷ 2) x 12 = 22.2%
- 34 strike: 1.12 ÷ 34 = 3.3%
- 35 strike: 0.73 ÷ 35 = 2.1%
- 97.50 strike 1.83 ÷ 97.50 = 1.9%
- 100 strike 0.85 ÷ 100 = 0.9%
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