Effectiveness of the put-and-call strategy

On August 8, 2018, from A. A. PhD., Columbia U. Professor Emeritus

Question:

How much does the put-and-call strategy change the annual percentage return (APR)?

Monday Morning Millionaire Program Answer:

It depends — like so much in the world of investing. Option premiums can be very high.

Suppose an investor writes cash-secured, uncovered puts on a market index exchange-traded fund (ETF). The investor immediately gets the premium income to use in any way. However, if the market price drops below the strike price at the expiry date, the investor is required to buy the ETF above the market price.  But, owning the ETF now allows the investor to sell covered calls on it and immediately receive the premium income to use in any way. Suppose that at the expiry date, the market price of the ETF exceeds the strike price, the investor will be required to sell it below market price.  That then again allows the investor to sell cash-secured, uncovered puts. The investor is whipsawed into buying above the market price and selling below market price. Nevertheless, the premium income often is more than sufficiently high to offset the pain.

For more on calls and puts, see Chapter 8 of Monday Morning Millionaire.

 

Dr. Milan Somborac

The Monday Morning Millionaire Program supports do-it-yourself (DIY) investors which I have been for over 50 years. About my team and me

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