OptionsHouse's Chief Investment Strategists Explains Options Strategies

OptionsHouse's Chief Investment Strategist Steve Claussen dropped by for a chat on the Benzinga PreMarket show on Wednesday. Claussen is always eager to share his knowledge of the market which is backed up by his career spanning over 25 years. When asked if a retail investor should be investing in options instead of equities Claussen first cautioned that with any investment, rule number one is not to invest with funds that an investor can't afford to lose. So with that emphasized is equities the best choice available to investors? “That might be the case,” Claussen said. “You might say, hey, Microsoft MSFT, good stock. Not going anywhere, I'm going to buy $10,000 worth of stocks. And that's OK, they pay a decent dividend.” However, an investor completing this transaction has essentially concentrated exposure to one stock, which is what Claussen calls a “concentration risk.” If an investor is exposed too much to one holding, they run the risk of not being able to maximize their return and outperform the major indices. This is where options comes in. “Options can allow a $10,000 portfolio to spread that around five different companies, or five different ETFs, or five geographical ETFs,” Claussen argued. He added that an investor who holds an option at the end of the day has the right, but not the obligation to outright own the stock. This strategy is best utilized by investors who at the end of the day may have an objective of owning the stock at some point in the future. As is the case with any investment, options do come with risk. An options holder in theory can see a 100 percent loss to their position. “In options, one of the main advantages is you are spending less for the leverage you get versus buying the outright stock,” Claussen said. Claussen is referring to the fact that options are leveraged, meaning an investor can stretch their money even further by buying options which on a dollar-per-dollar basis is cheaper. Claussen offered an example to show how options offer leverage using a stock that he holds in his family portfolio, Disney. DIS If an investor bought 100 shares at $80, it would cost $8,000. Alternatively, an investor could purchase a call option for $75 per share, thereby gaining the same exposure to any rise in Disney shares while paying less. Naturally, it is important to consider that options, unlike stock, have an expiry date. Once an option expires, it no longer has any value. Timing is critically important, according to Claussen. In the Disney example, an investor who purchases an $82.50 out of the money call option would need shares of Disney to trade above $82.50 (known as the ‘strike price') mark to earn a profit. Many novice investors would foolishly invest in an out of the money option chain only to see their investment lose value as shares fail to rise above the strike price. Claussen's advice to new options trader is to create an options position that acts very much like a stock and its movement is more predictable. This is typically done buy buying an in the money call option has both an intrinsic and extrinsic value. Intrinsic value refers to the difference between the stock's price and the option's strike price. As an example, if a call options strike price is $15 and the stock is trading at $20, the intrinsic value of the call option is $5. Extrinsic value is the amount that an option's price is greater than the intrinsic value. This value declines as the expiration date draws closer. “Out of the money options are 100 percent extrinsic value, they are a 100 percent wasting asset. In the money options, the portion that is in the money is not a wasting asset,” Claussen argued. A popular strategy that investors are utilizing would be replacing their stock holdings with an option that has a delta of 0.7. A delta of 0.7 implies for every $1 the stock increases, the call options will increase by $0.70. If the stock continues to appreciate, the delta on the option will increase. By doing so, an investor is making less money as they would with owning the stock, but the investor has minimized his total liabilities by purchasing options for a cheaper price. What if an investor doesn't want to sell their stock but incorporate options to protect a profitable position or limit downside? According to Claussen, an investor could keep their long position and reduce their exposure by selling a call option to collect a premium. Claussen gave a hypothetical example of selling an out of the money call option at a price that the stock may not reach. In the event that the stock in fact does not reach this price point, the investor keeps the entire premium received. Selling an option involves substantial risk and should only be performed by sophisticated investors. Less sophisticated investors could consider buying a put option which locks in a buying price for the investor to sell their stock at in the future.