When using options it's important to employ strategies wisely so
you can maximize returns while limiting risk. Today, we'll cover
the buy/write strategy.
[caption id="attachment_64545" align="alignright" width="300"
caption="Melco's City of Dreams complex in Macao"]
Last week, we looked at the fundamentals of
using a covered call to increase return on
. Before employing a buy/write strategy, you must understand how to
write a covered call as the buy/write method is a specific covered
While writing a covered call can be applied to multiple
different scenarios, a buy/write play is very specific.
Essentially, a buy/write strategy is when a trader starts a
position in a stock in increments of 100 shares -as you'll recall,
options are sold in lots of 100 shares-and instantly sells -or
'writes' in options speak-out-of-the-money or at-the-money
Before employing a buy/write strategy, traders should identify
an equity with both of these attributes: high implied volatility
and a stock with moderate-to-good prospects.
Traders tend to employ this strategy when a given stock's
options have high implied volatility. Otherwise, the potential
opportunity cost outweighs the options premium derived from selling
You also want to find a stock about which you feel moderately
bullish. A buy/write strategy does not work particularly well when
trying to bottom pick. Take for example, Research in Motion (
), which has had high implied volatility for the past few months.
However, had you decided to try a buy-write strategy in this name
six months ago, because
the market has thumped RIMM
, your initial principal would be roughly halved now.
This is why I prefer to employ a buy/write strategy with stocks
about which I'm moderately bullish in the short-term, but that I
don't think will drop precipitously, or stocks that I'm comfortable
owning down another 10% or 20%.
In the emerging world, one name that fits the bill is Melco
Crown Entertainment (
). Although growth in Macao may be slowing, gaming revenues in the
former Portuguese enclave are still strong. Although a stock with
, it tends to whipsaw, causing options for MPEL to be relatively
expensive. At its closing price on Friday, $10.84, you can buy an
11 strike call for the month of August for $.65. This option offers
roughly 6% downside protection and almost 8% profit if the stock is
trading above $11.65 at expiration.
The point of such a trade is to make a relatively quick profit
-- 8% in a month and a half's time -- while also affording downside
protection. Now, such a strategy can severely cap your profit
potential, but in a volatile market like the one we're in now,
sometimes it behooves traders to try to hit singles instead of home