Put Plays and Covered Calls

06/10/2014 12:01 am EST

Focus: OPTIONS

John Dobosz

Editor, Forbes Premium Income Report and Forbes Dividend Investor

John Dobosz, of Forbes, explains the factors of this options strategy and offers several current plays in the healthcare and biotech sectors.

SPEAKER 1:  Hi, I'm here with John Dobosz, editor of Forbes Dividend Investor and Forbes Premium Income Report, and we're going to talk about the options strategies for income that he puts out in the Premium Income Report.

JOHN:  Hey Jeff, all right.

SPEAKER 1:  How you doing?

JOHN:  Good, good.

SPEAKER 1:  How does it work?  What kind of options do you work with?

JOHN:  Puts and calls.  We sell cash-covered puts; cash-covered means - well, let's back up a little bit.  A put, if I sell a put, it obliges me to buy that stock at the strike price before the expiration, if the price goes below the strike price, so you've got to have cash or margin with your broker to buy that stock in case, so you sell a put, and we also sell covered calls.  Covered calls means you own the stock, you go along the stock.  It's called a buy right, actually, if you buy it and sell the calls simultaneously.  Let's say a stock's trading at $25.  You like it, but you want to get a little extra income out of it, maybe you sell the $26 call after you buy it at $25, so if it goes above $26, you've got to say sayonara, and be happy with that one out of 25, which is a 4%, and if you do it, try to do it for less than two months, the expiration, so you can do it many times a year.  If you do it two months apart, you can do it six times a year.

SPEAKER 1:  When do you want to get into one of these put plays or covered call plays?  At what point in the stocks history?

JOHN:  In the stocks history?  Well, a put, basically, you want to sell a put, write, sell, same thing.  You want to sell a put when you would not mind owning a particular stock at a price that's a little bit lower than where it is right now.

SPEAKER 1:  A lot of people say it's better to sell a put than buy a stock.

JOHN:  Options, I can't confirm or deny this, 90% of them expire worthless, so you're better to be a seller of options premium than a buyer of them.

SPEAKER 1:  When do you want to get one of these covered calls?

JOHN:  Covered calls, let's say a stocks up a couple percent in the day, people are stoked, they want to buy the calls, so the calls go up; the stock's up, too, but you can sell that call for extra money and buy the stock.  You want to get it when it's either flat or rising slightly.  A big bull market, you'll get called away prematurely in the covered calls.  Did a couple of them recently.

SPEAKER 1:  Yeah, what's a couple ideas you had?  One put and one call.

JOHN:  Put?  Okay, let's go with the cash-covered put.  Merck, everybody knows Merck, been around since 1891, big drug company.  They had earnings out a couple weeks ago, not so great.  The stock was down from 59 to about 55.  In a very recent issue of the letter, I said sell the $55 Merck put that expires very soon, in June, so you've only got a month to go, a little bit less than about a month, and so if Merck drops below that, we own it at about $53.30, because we got $1.70 per share in premium for selling that, okay, so I wouldn't mind that.  Merck's a 3.2% yielding company, the management would have great gastrointestinal pains if they cut the dividend.

SPEAKER 1:  You like Merck, you sell a put.  What about on the covered call side?

JOHN:  On the covered call side, biotech stocks have been volatile.  Great last year, great beginning of this year, then they got slammed.  One of the biggest of them, Gilead Sciences.  They came to fame with the AIDs cocktail and they make a lot of anti-viral drugs.  They took a beating, they're on their way back.  I said buy the stock at around $80 and sell the $82.50 call that expires in July, so you've got about two months to go, if Gilead really gets hammered, which you've got to do if you want to honor that 10% trailing stop loss is to buy back the call, which would be cheaper if the stocks going down, and get rid of your position, but if all goes well, and Gilead just kind of hangs around the 80-ish level until June, we picked up about $2.50 per share.

SPEAKER 1:  And you lower your cost basis.

JOHN:  And you lower your cost basis in the stock, exactly.

SPEAKER 1:  Thanks so much John.  Thanks for joining us at MoneyShow.com.

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