3 Most Effective Options Strategies you need to know of

The continuous  stream of blistering headlines with some combination of phrases such as “Fed raising  interest rate”,  “Sky high inflation”, “World War III?” are abundant these days.  Headline news move the market, along with investor portfolios and their anxiety levels. How do you make sure you ease your investment journey and avoid painful losses when things get rocky, while not missing out on the great long term return? “Buy, hold and hope for the best”, easier said than done, since nobody has a crystal ball to predict the future. However, there are ways for you to outsmart the volatility and protect your investments, like: a well executed option strategy. 

Over the years, CSuite Investment has helped numerous executives and early startup employees in Silicon Valley that had concentrated portfolios, which faces heightened levels of risk especially in today’s environment. It is typical of Silicon Valley to come across individuals owning the stock of the company they work for, since stock options are a big part of their compensation, making up to +95% of their net worth. The reason this scenario is extremely risky is that, should any bad news come out in regards to this company, they are typically the most penalized of all. Not only do they expose themselves to potential job loss, but you could also suffer significant wealth evaporation. Market does not always reward for outsize risk taking with outsize return, the market assumes you have diversified your risk and managed the downside risk accordingly. In addition, technology companies are typically known to provide growth, and their high-growth (factoring future income) translates into higher valuation. However, as the interest rate rises, the valuation of these companies will have an inverse effect on their stock price. For instance, in last three months , some of the high-flying stocks/etfs  who were winners during the pandemic such as ROKU, ZM, ARKK,  are now under extreme pressure down  -40.89% , -40.77 %, -35.60%, since the Fed announced they were raising rates.  

Here are 3 different options strategies that can help you to various degrees to mitigate the risk from the  concentration stocks/etf positions. Please speak  to your financial advisor and tax advisor for specific recommendations that best fits your need ,  investment timeline and risk tolerance,  before implementing any of these strategies. 

3 options strategies for volatile market:

     I. Covered Call

     II. Zero Cost Collar

     III. Hedge

I. Covered Call

Let me break this concept down for you. Typical stock trading compares to someone owning a cow, and waiting to sell the meat at the right time to make the most money, when the excitement of the population for this type of meat is at its peak. This option strategy compares to having this cow owner putting the cow to work, while he/she owns it and sell its milk all along the way, then sell the meat when the time comes. 

This strategy is great for clients holding concentrated stock positions with a “bullish” view (you think stock is going up higher from current price), but want to maximize income in the meantime. You are comfortable selling the stock at a predetermined price,  and are receiving a premium to do so. By virtue of writing covered calls, the income generated by the strategy will lower your cost basis.  

Let’s take an example of a stock that you own at a cost basis of $200 per share  and is currently trading at $200 per share. By writing a covered call at $250, you agree to sell the stock, if it hits that price or above. Let’s say you wrote the covered call and received $10 per share for a specific time frame. Now, if the stock goes to $250, you will sell the stock at that price plus the $10  per share ,so a total of $260. On the other hand if it goes down to $190,  then you lost nothing, since you already pocketed the $10 per share from the strategy. Now, you can repeat the strategy over and over again to create more income until the stock finally gets sold at the price you want and diversify out of it. In the meantime , the income generated can be used to buy new sets of stocks with minimal correlation to your concentrated holding.  

II.  Zero Cost Collar

This strategy is  like having an insurance policy that pays for itself, while you can benefit completely if things go bad. It requires no out of pocket cost to the investor. 

This is good particularly for investors who don’t have or want to put more money in to protect their investment. The strategy works as follows, you write a Covered call on the stock as explained above and use the premium income from the strategy to buy puts at lower strike price. 

Here is an example: your cost basis is $200 per share and is trading at $200 per share.  You wrote a covered call at $250, and received $10 per share for a specific time frame. Now , you buy a $200 Put for $10 per share for the same specific time frame, by buying this Put, if the stock goes to $170  you have the right to sell your share to someone else at pre pre-agreed price of $200. Instead of losing $30 per share, your total loss at this time would be $0. However, in order to hedge 100%, you would have to limit the upside, and be willing to accept a bit of downside if you want to build a zero cost collar . This strategy will put the stock in a range where you are comfortable holding, hence limiting the volatility , in this case $200- $250. 

III.  Hedge 

This strategy is just like buying car insurance, but with more flexibility to sell your insurance back to the market if you don’t want it anymore.  A 100%  hedged  position will protect the stock and etf from any downside movement.

This is an extremely useful strategy for someone if  capital required to purchase “protection” is not an issue, and do not want to cap his/her upside potential from the stock.  

Let’s take the above example. The stock is trading at $200 per share, and your cost basis is also $200. You believe stock will go to $400 long term. However, in the short term, due to market jitters on fiscal policy, monetary policy or politics, you are conscious that market sentiment is going to be sour on your stock. Thankfully, you are a patient investor. Then, you can simply buy Put on the stock for the time frame, and pay the premium to buy the Put based on your  stock movement expectation. If the stock falls below the strike price  (let’s say you bought $200 Put at $30 per share), and is now at $150, you are completely protected. By purchasing the Put, you have an agreement with a third party in the market to buy your shares at $200 per share regardless of its market price. Now, since you want to hold the stock long term you can turn around and sell your Puts you have purchased for $30 per share and sell it for $80 per share, making a cool profit of $50 (Put price $80 – Put Cost $30). Let’s say the market rallies back and your stock heads to $400, you make additional profit on the stock as well. 

The value of the option premiums are  based on the volatility of the stock, market moving news, earnings,  time frame and market expectation of the stock which are all to be considered when designing the specific strategies.

Intelligent investors these days must have to consider these strategies to protect themself during these uncertain times, where dictators are unfortunately provoking wars on a whim.  These strategies are highly utilized by high networth individuals and institutions , I urge you look into option strategy to protect your wealth during these crazy times !! CSuite Investment is here to help provide guidance in any of the  above mentioned strategies. Please email :sam.timilsina@csuiteinvestment.com if you have any questions.. 

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