Credit: 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 align="alignright" caption="Melco's City of Dreams complex in Macao"] 
[/caption]
Last week, we looked at the fundamentals of using a covered call to increase return on investment . Before employing a buy/write strategy, you must understand how to write a covered call as the buy/write method is a specific covered call strategy.
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 options.
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 a call.
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 ( RIMM , quote ), 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 ( MPEL , quote ). Although growth in Macao may be slowing, gaming revenues in the former Portuguese enclave are still strong. Although a stock with decent fundamentals , 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 runs.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
