Another Way to Profit with Options—in “STRIDES”

01/04/2010 10:57 am EST

Focus: OPTIONS

Bryan Perry

Editor, Cash Machine, Premium Income, Quick Income Trader, Instant Income Trader

Typically, when you're trading options and want to employ something more than a basic strategy such as buying a call or a put, you have to either "know your stuff" or have a broker who knows theirs.

However, you can make a multi-part trade in one single step. And this one doesn't even require you to have an options-approved account!

Callable stock return income debt securities (STRIDES) are like purchasing an all-in-one Thanksgiving dinner package from your local supermarket. You get the main course (in the form of a play on the stock), side dishes (a bond and dividends), plus a dessert (an option strategy). But instead of leading to a tryptophan coma, this package deal can reward you for partaking in a veritable investment buffet in one trip.

To participate in a stock's potential upside, STRIDES use a short-term bond coupon that is married to an option strategy. These are Merrill Lynch (MER) products that serve as hybrid-type securities that are structured like bonds and that mature in a fairly short time frame (one to two years). Even better, they pay dividend yields, the target percentage of which is listed in its name.

For example, if you think JetBlue (JBLU) is about to take off, you may want to look into the Merrill Lynch JetBlue 10% callable STRIDES (STRIDE ticker: CSJB). Unlike "regular" options, which can trade on any combination of the six US options exchanges, note that the JetBlue STRIDES only trade on the Nasdaq, as that is where its parent stock is listed.

But not all STRIDES show up on the Nasdaq (NASD). ExxonMobil (XOM), which trades on the Amex, has its ExxonMobil 9% callable STRIDES (STRIDE ticker: MIX) listed on the Amex as well.

The dividends you receive are based on the STRIDES, not on the underlying stock itself, as you don't technically own the stock, and therefore, you don't receive the same rights as a shareholder (i.e., dividends, tender offers, voting rights).

Essentially, the STRIDE functions as a covered call strategy in which you are theoretically holding the stock and selling a call against it. In this case, Merrill Lynch is the call buyer, and thus, has the right to exercise the rights which owning a call gives them. As the call seller, so to speak, you are entitled to premium collected during the life of the investment.

Just like options, these "callable" securities can be called away before their term is up. If a brokerage firm makes the call, then you will not receive shares of the stock or any scheduled yields between the call date and the maturity date. If shares are not called before maturity, then you would be issued stock in lieu of cash.

If the underlying stock should fall, Merrill can choose to redeem your STRIDE, whereupon you can receive shares, unpaid interest, and interest that would have been due to you during the remaining life of the STRIDE.

Merrill Lynch's Web site explains how this can protect you if the stock falls: "If the callable STRIDES pay an annual coupon of 6% over two years but, at maturity, the underlying stock is down 10%, you will actually be up approximately 2%, due to the fact that you have received a 6% coupon in both the first and second years."

Like any type of investment, STRIDES are not foolproof money-making vehicles. Because they are not widely known, they are not highly liquid. Typically, when you're trading stocks and options, liquidity is a huge "must have" on the checklist, because not only do you want to be able to easily buy them, but you also want to be able to sell them when you want to.

Less liquid securities are more challenging to cash out of when buyers aren't easy to come by. For example, the JetBlue STRIDES are currently trading at $15.71 a share and carry a dividend yield of 2.7%. However, they didn't move in price in more than a year and a half, but those who have been in this position that long enjoyed a 35-cents-per-share dividend.

STRIDES are also available in Apple (STRIDE ticker: AVN), Best Buy (STRIDE ticker: BLB), and Caterpillar (STRIDE ticker: STF). Note that because STRIDES function similarly to covered calls, they may be best utilized when you anticipate the underlying stocks won't make a dramatic movement (up or down), as these strategies are designed to generate income in exchange for a capped downside risk/upside return potential.

You should talk to your broker to see whether STRIDES are right for you. But if you are looking to buy any of these stocks and sell calls against them for income, or if you're looking at buying LEAPS on any of these names in lieu of the stocks themselves, STRIDES can serve as a one-stop shop to let you be in a name for the same amount of time as holding an option, while collecting income in the interim.

By Bryan Perry of OptionsZone.com

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