Investors can increase their returns with options, but there are also risks
A foray into the world of options trading could offer some investors a way to make money without investing tons of cash in securities — but they should first make sure they understand the risks. The opportunity lies in cash-backed puts, a strategy in which investors sell put options — an instrument that gives the holder the right to sell an asset at a specific price — on securities they believe will sell at a specific price period, for a premium. Investors then set aside the money they would need to buy the underlying security — a single stock or exchange-traded fund — if the option is exercised, hoping it won’t be called and they can keep the premium . “They are essentially suspending this put contract and betting that security is going to increase,” said Ashton Lawrence, financial advisor at Goldfinch Wealth Management in Greenville, South Carolina. “Someone is on the other side and saying it’s going to go down.” A Few Key Caveats While the strategy may sound simple — it’s basically betting on a rising stock — the process is a little more complicated. First, such contracts require investors to promise to buy 100 shares of a stock or ETF. Say a stock is currently trading at $100 per share and you think it will either stay relatively flat or go up. If you sold a put option on that stock at $90 per share that expires in three months, you would need to set aside $9,000 to cover the position. If you sold the put, you could get a $500 premium, which is yours regardless of what happens to the underlying security. If the stock costs more than $90 in three months, the contract expires worthless and you don’t have to buy the 100 shares. That means you keep your $9,000 plus get an additional $500 in bonus from the contract — a return of nearly 6%. “It’s an income strategy where you’ve eliminated the risk of having to buy the stock even though you have the money,” said Douglas Boneparth, a certified financial planner and president of Bone Fide Wealth in New York. But you can also get hit. If the stock you sold falls below $90, you must buy the security at the agreed strike price after three months. This means that even if the security falls to zero, you are required to pay $9,000 to buy the 100-stock position. While you can keep the $500 premium, you’ve spent $9,000 on a stock that has fallen in value. “That’s the big risk,” Lawrence said. Of course, most stocks wouldn’t necessarily crash, but could instead just fall slightly below the strike price and still trigger a 100-share buy. There’s also a bright spot: You’ve snagged stocks at a discount — which is why it’s important to base this strategy on stocks you actually want to buy. Choosing Puts Because you may be looking for a significant position in the security you are selling puts on, it makes sense to choose the asset carefully. Lawrence suggests picking stocks that you want to own or that you already own because you think they will appreciate. Then if you have to buy the position, hopefully it’s not a big hit. “What I want to emphasize with people is to still look at this as part of your overall portfolio,” he said. That means you are considering how potentially buying 100 shares of your chosen security will change your allocations. If it’s clearly going to get you all over the place in one area or stock, take note and plan to diversify. Because of the complexity of this trading, Lawrence suggests working with a financial advisor or money manager who is an expert in options trading rather than doing it yourself. Boneparth added that options trading may not be a good idea for most investors as it may not add value and could instead be a distraction. “For most investors, this probably isn’t something they’re going to do because investing and discipline is hard enough with long-term investing,” he said. “If you add option strategies, it may deviate from practicality.”
https://www.cnbc.com/2023/01/18/investors-can-boost-income-using-options-but-there-are-risks-too.html Investors can increase their returns with options, but there are also risks
