Monday, December 29, 2008

LEAP or no LEAP?

Clueless has been mentioning his LEAP positions lately so, being a pitiful copycat, I thought I'd look at what some LEAP opportunities might look like to generate a little premium decay for the coming year.
This is obviously a small sample . . .GE, XLE and the Qs and only examines the ATM situation as of Friday's closing prices. We can go a lot further with this study if sufficient interest.
Top to bottom are the Jan, Mar, Jun and Jan10 option strings for GE, XLE and the Qs. I've highlighted the ATM option strikes on each matrix.

Below is a little spreadsheet showing the relative payout for each of the ATM positions over time. %ROI is the total premium received based on a current Buy/Write position.
Monthly Y is the % premium received divided by the number of months the position is held.

With relatively high quality CDs currently paying about 2-2.5%/ year, this approach certainly looks like something to consider. The overall annual average return of 20% for this little basket also provides a nice cushion in the event of further declines and involves basically no monitoring, although working this thing a bit with a timing model can double or triple your returns. The ROI potential is clearly maximized by using the shorter term options, a fact known to anyone who actually trades options, but cyclical price movement can significantly effect the ability to produce a continuing level of premium decay if, for example, the market were to drop another 20% in the next few months. This risk management trade off has be to closely considered. . .pay me now. . .or maybe pay me later.
A obvious simple strategy here is to spread the position over a number of strikes to both hedge the position if the markets fall and to allow for some good gains if the markets rise.
Of course, you could just sell puts . . . this is the other side of the coin and will be examined in a future post.


Rik said...

Are you talking here about writing covered calls, buying the stock and selling calls?

bzbtrader said...

You are correct. That is why I added the comment about just selling puts. It achieves the same net position and many brokers allow this trade in IRA accounts.

joshua said...

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