3 Option Strategies to Enhance and Augment Stock Picking

06/29/2015 8:00 am EST

Focus: OPTIONS

Gregory Harmon, CMT

Founder and President, Dragonfly Capital Management

Greg Harmon, of Dragonfly Capital, shares three reasons why—once a trader has made the decision on what stocks to buy and spent the money in his brokerage account—it is time to look to the options market.

Plenty of people own stocks. Your mom and dad, grandparents, kids, professional investors, your barber or hairstylist, and of course, playboy playmates like stock trading Kennedy Summers, Playboy’s Stock trading 2014 Playmate of the Year. And everyone has a different method for picking stocks. Maybe it’s using fundamentals, or just watching price flow for a quick trade. Or maybe you are like me using technical analysis to find trade ideas.

It does not matter how you decide when and what stocks to buy, once you have made that decision and spent the money in your brokerage account, it is time to look to the options market. Here are three reasons why.

Covered Calls

Selling Covered Calls is a strategy to add extra income to your portfolio. All you do is sell one call at a strike above the current price for every 100 shares of stock you own. It is simple but can vastly improve your return. But which strike and which expiry? Ah, here are my rules.

Look for at least 1% of the stock value per month you will be short the calls. Aim for short-term one month to six weeks for the most control and generally not beyond three months. The strike has to line up with the technical resistance or at least not impede a price move to a nearby resistance level.

The stock should not be reporting earnings in that span, or if it does, the strike needs to be adjusted for the potential earnings move. And the strike should not cap the trade below a strike with a large open interest the same expiry. These don’t have to be hard and fast rules but a guide as you can always roll the Covered Calls up and out.

Stock Repair

The stock Repair strategy can be used when you bought a stock and at some time when you were not looking it took a dive lower. Not enough to sell, it but enough that you wish it were not that low and could make up money more quickly. Stock Repair is a variation on the Covered Call strategy, in that it starts with a Covered Call and then adds a Call Spread along side.

The goal in a Stock Repair Strategy is not income, but added upside leverage. Look near term, 1 to 2 strikes out. Look for a combination where the 2 sold calls at least pay for the purchased call, so there is no cost to you or a credit added to your account. After executed, the plan is to trade the call spread separately from the covered call. So if the stock rebounds quickly let the call spread max out and look to roll the covered call up and out. Now you are happy with a higher priced stock and a lower cost basis.

Collar

The Collar is driven from a desire for protection against a move lower in your stock. It is nothing more than buying a put or put spread for that protection and then selling a Covered Call to fund the protection cost. This can be used at any time but many investors use it around news events like earnings reports, conference appearances, or drug trial results.

When executing this strategy, look first for a put strike that goes just beyond your date of concern and is very close to the current price or another meaningful price level like your stop loss level. Then look for a Covered Call to sell, usually 1 or 2 expiry’s beyond the expiry of the puts to sell to cover the cost.

If the call does not cover most or all of the put cost then look at whether or not it is worthwhile to also sell a put with a lower strike, to make a put spread to help fund the strategy. This will cap your protection so make sure if you add this step that you use a strike that makes sense from a technical or other perspective.

With these three strategies to enhance and augment your stock picking, you will be able to sleep better, earn more, and recover faster.

By Greg Harmon of Dragonfly Capital

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