Here are different options strategies that offer a good risk/reward ratio.
Undervalued Dividend Paying Stocks
Long-term options on high dividend paying options have low prices because the upside on the price is usually limited. However, sometimes the dividend paying stock is undervalued, and options are the best way to establish a long position in the stock.
A case in point is CommonWealth REIT (CWH). CWH is a REIT that owns and rents over 500 office properties worth over $6 billion mostly in U.S. Due to inept management and a recovering economy, the company’s profits are down. Now there are concerns that management might cut the 14% dividend yield. As a result, the stock price is down over 25% to $14.35, and the company trades at around 40% of tangible book value.
The company is severely undervalued, and there are catalysts that could take the stock price higher.
- Economy improving. Obviously the office properties rental market is highly dependent on a strong job market.
- No dividend cut.
- Activist investor buys a substantial stake in the company and unlocks the real value of the company.
Because of the horrible management, it is no advisable to buy the shares outright. However, the April $15 Jan 13 calls are very attractive and trade around $.40/share. If the stock price goes from $14.35 to $20, you will make 11.5 times on your investment. A $1,000 investment would make you an $11, 500 profit. Also, the maximum you could lose is $.40/share.
New York Community Bancorp (NYB), “a multi-bank holding company for New York Community Bank and New York Commercial Bank”, is another one that is attractive. Although, it is not undervalued like CWH, it pays a 7% yield. Investors looking for income could cause the share price to increase. The stock price is $14.74 and the April $15 Jan 13 calls trade around $.50/share. It is entirely possible the stock could go as high as $20. At that price, it will stay pay a juicy 5% yield.
Selling Puts To Buy Shares
A way to make a little extra income, and buy a company that you are really bullish about is to sell very short term puts on the company. A put allows an investor to sell a particular stock for a specified price by a certain date.
For example, one of the companies that we are bullish on is General Motors (GM). It is currently trading around $24.50. If we want to buy the shares at or below $24, we could sell the October $24 puts for $.41. These options expire in a little over 2 weeks. If the price of GM stays above $24, we make $.41. If it does not, we bought a company that we plan to hold for a long time at $23.59.
Warren Buffett uses this strategy to establish big positions in companies. However, this should only be done with companies that you are overly bullish about.
Every investment strategy is different. Sometimes options allow investors a better way to invest than just buying or selling the shares outright.
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Disclosure: I own shares of GM, CWH. I own options on CWH.