Brainstormer Series— Options: the 3-Dimensional Market Tool
Updated: May 23, 2020
MEET ITALY and the Italian Cultural Institute are proud to present a new brainstomer on understanding options as a strategic tool for portfolio management. In this complementary session, attendants will learn the basics of options and focus on risk management and stock acquisition strategies. Prof. Davide Accomazzo will host the session.
The event is scheduled for June 6th, 2019 (Thursday) from 6PM to 8:00PM at the IIC in Westwood. At the end of the presentation, a networking session will follow to discuss ideas on the future developments of the Meet Italy platform. The brainstormer is complementary but it only has 12 available spots. To RSVP and get full details please email: email@example.com
The following is an excerpt from Prof. Accomazzo’s research on options:
As the markets become more uncertain and momentum wanes, a more selective and active approach is required to possibly achieve outperformance or at least avoid undershooting pre-established targets by dramatic margins.
Year of successful Beta-driven results (performance based on pure market momentum) have conditioned most investors in seeking purely passive investment strategies. However, as correlations decrease and volatility increases, more creative and more active approaches may be in order.
One strategy which institutional investors have implemented for years to attain a more selective approach to stock ownership is the so-called Cash Covered Equity Put strategy.
In this case, an investor gets to buy stock at a discounted price and he/she gets to collect a premium while waiting for execution.
But how does it work in practice and what are the risks involved? In this strategy, an investor sells a put option at a strike price below the current market price of the desired stock and collects a premium for taking on the obligation to buy the stock at that predetermined price.
Let’s assume we like Apple, but we find the current price of $195 per share excessive, we could then sell a put option with a strike price of 180 (which means we agree to buy the stock a 180, should Apple drop below that level) and in exchange we receive a premium. Simultaneously, we set aside enough cash to cover for the possible situation in which we may have to purchase the stock.
In essence, what we are really doing is to place a buy stop at a level which we find attractive for that particular stock and we get paid to wait for execution! Additionally, the cash used as collateral will continue to earn risk free interest (albeit rather low these days…).
The risk involved is that the stock might trade significantly below the strike price. In this scenario, the put will be assigned and the investor will become long the stock at the strike price carrying an unrealized loss in his/her position. The maximum loss would be if the stock drops to zero, in which case the loss will be the total invested in the stock minus the premium received for the put option. Of course, this would have happened even in the situation where the investor buys the stock using a simple buy stop order. In this case, however, the investor would not even have the consolation of the option premium received. This scenario is an extreme case and it also implies that no risk management will be used at any time during the trade.
Naturally, the key is to select equities that provide certain favorable characteristics. For instance, one should look for companies that can comfortably be owned for a reasonable investment horizon. Strong franchises, with good dividends undergoing short-term turmoil are often positive candidates. Special situations are also possible contenders.
The Cash Covered Equity Put strategy can also be complemented with additional options overlays if the puts get assigned. For instance, one could receive premium for selling the put, get assigned, use the secured cash to buy the stock and then sell calls against the new long position and receive more premium.
Ultimately, this strategy is an optimization of the process of acquiring stocks, especially in a market that may see more volatility occurring. It also a clever way to force selectivity and a more active role in building net-long portfolios. It can also be considered an income enhancing strategy because of the premium that is recurrently received.
Over the years this strategy has been implemented not only by institutional players and options traders but also by tech companies as part of their buy-back programs, a validation of the merits of this approach.
To RSVP and receive more details please email:
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