Short Options to Take Profits (Without Selling Stock)
Playing short-term volatility swings is fairly straightforward using long calls or puts, but both require you to pay money.
The alternative of receiving money to play the same swings is very appealing - and it makes sense as long as the risks are manageable.
The situation arises when your long stock values rise and you expect some of the price movement to reverse and go back to the previous trading range. So do you sell and take profits now while you can? Or do you hold on through the volatility?
If you believe the current price rise is temporary, another alternative is to sell one covered call per 100 shares you own. If your assessment of conditions is right and the price does retreat, you can buy to close the call and take profits – without having to sell your stock. If the timing is wrong and the stock price rises, your shares could be called away. Or you can close the short call or roll forward to avoid exercise.
MGM Resorts International (NYSE: MGM), for example, closed on June 26 at $10.58. If you expect this stock to decline, you can play the swing by selling the August 10 calls. These closed at 0.83, which is a 7.8% return based on the day's closing price. If you are correct and the stock declines in the next few weeks, the short call can be closed at a profit or, as long as the price moves below the strike, let it expire worthless.
The same strategy is used when the price declines. If you are sure it's only temporary, don't sell shares to cut your losses. If you sell puts instead, you get paid and if stock values do rise, you keep the premium and make a profit.
The risk here is that unlike the call, the short put is not covered - so you could end up getting exercised and having 100 shares put to you at the strike. You do have to be prepared for this, but if you think the strike is a reasonable price for shares, it can be a great way to play the swings using short options. You cut your risks by getting paid, and time decay works in your favor. For this reason, focus on contracts expiring in two months or less then time decay is most rapid.
As an example, China Southwest Airlines (NYSE: ZNH) closed on June 26 at $21.94. If you believe this stock is likely to rise in coming weeks, you can sell a put. The August 20 was at 2.80 (12.7% of current price) and the 22.50 at 4.80 (21.9%).
These are both amazing rates of return. If the stock rises and remains above the strike you pick, these puts will rapidly lose value in the coming 52 days until the last trading day. In both instances, time is on your side.
Options can help manage price swings in your portfolio, without having to dispose of shares you think are worth owning for the long term -- either to take profits or to cut losses. The issue is one of how to manage volatility. This is a difficult task, and many options traders can benefit by getting valuable help.
It is wise to take a look at methods for tracking IV on the stocks you own, as part of your options strategy. A volatility-based strategy can be complex without help, but it can be simple and easy with the right tracking tools. To improve your option trade timing, check the Benzinga service Options & Volatility Edge which is designed to help you improve selection of options as well as timing of your trades.
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