It’s a scary time to be committing new capital to equities. We’ve been very clear about the caution that investors should be showing in this environment. We detailed tactical portfolio hedges right before the New Year, and those have worked well and we recently rolled them lower. What’s nice about having overall protection through the use of options is it gives you the freedom to start looking around for relative bargains while everyone else is freaking out about the market weakness.
As far as what stocks to buy we have been detailing defensive stocks with good yield and low or no exposure overseas where other multi nationals are having difficulties with weak demand and a strong dollar. One of our recent trades was in Verizon (VZ) which fits that criteria quite well. Here was our trade last week:
*Trade: VZ buy 100 shares for $44.60 and sell 1 Feb 46 call at 45 cents
This a simple buy-write where we own the stock then try to add yield to the position with the sale of an upside call. In a stock like VZ we can create a sort of super yield situation where we have the potential to collect short call premium and dividend yield on top of any gains in the stock if our entry is correct. In the case of VZ the stock is indeed higher but now threatening our short call strike. So let’s look at how to manage the trade:
With the stock now 45.80, we have a gain of 1.20 in our long stock but losses in the short call. We sold the Feb 46 call at .45 and now it’s worth .82. That means the short call has cost us .37 in profits. But the overall position is sound as long as the stock stays near the strike. It becomes an issue above the Feb 46 strike but even then the overall position is long deltas and so we can be patient. If the stock settles near here we can also be patient and let the short calls decay a bit, and then possibly roll them up and out a month if we still have gains in the stock and want to stay int he position. The bigger risk to the position is lower but we’ve built in some protection with the short call and our purchase price has an effective cost of 44.15 so we can use our purchase price as a stop to the downside.