Bull or Bear, Profit Anyway

Following last year's record rebound, and awaiting economic data along with January and February earnings reports, everyone is on pins and needles waiting to see if stocks can continue their enthusiastic climb.

Will there be a recovery in the United States? Or will we just muddle along? We'd all like to see a recovery, but that's far from assured. And even if we enjoy a broad economic recovery, it may not lead to more stock gains in the near term, because the market has already soared in anticipation of a stronger economy.

The market is usually a few steps ahead like that, which makes predicting it nearly impossible. Thankfully, we don't need to know what it will do next. We have strategies that can profit whichever way stocks turn.

Profit whether up or down
Most of us have favorite stocks that we've been comfortable with for a long time, stocks we don't expect to soar anytime soon, but which we wish to own regardless. Maybe you'd like to buy more, too, if the price declined.

But it all depends on the market, right? If it goes down, you'll buy. If it goes up, you'll sit on what you have or sell at a higher price.

What you may not know is that those stocks could be generating profit for you even if the price they're selling for barely changes. In fact, this unclear market situation may be perfect for setting up income-generating option strategies called ... drumroll, please ... strangles and straddles.

Strangle profits from the market
Let's assume you own at least 100 shares of networking giant Cisco Systems (Nasdaq: CSCO  ) , recently $24.30 per share. If the shares declined, you would be happy to add another 100 shares to your position. (All options contracts work in 100-share lots.) If the price appreciates, you'd be willing to sell your existing stock. This situation is ideal for writing (or selling) a strangle option strategy.

Writing a strangle, you sell put options on a stock at a strike price below the current share price, and sell covered call options on your shares, too, at a higher strike price -- selling the same number of contracts of each.

The puts obligate you to buy more shares if the stock falls by expiration, and the calls obligate you to sell your existing shares at a higher price if the stock appreciates by expiration.

You're paid for selling both options, putting significant income in your pocket:

Selling Puts

Cisco Systems

Selling Calls

Combined Options

July $23 strike pays you $1.18

$24.66

July $26 strike pays you $1.15

$2.33 payment to you, or 9% of the share price

Source: TD AMERITRADE quotes, Jan. 11.

This strangle trade pays $2.33 per share today, or $233 for every $2,466 in stock that you own. This 9% income is yours to keep.

Your obligations? If Cisco shares are below $23 by the July expiration date, your puts obligate you to buy more shares. Since you keep the $2.33 you were paid, your effective net buy price is $20.67 -- far below today's price. On the flipside, if Cisco is above $26 by expiration, you're obligated to sell your existing shares. Your net sell price equates to $28.33 -- a good sell price.

If Cisco is anywhere between $24 and $26 at expiration, both options you wrote expire, you keep the full payment, and you have no further obligations -- you just made great income even while the stock was flat. In fact, if Cisco is anywhere above $20.67 and below $28.33 by expiration, you can close your option trades for a partial profit and still not have any other obligations. That's a wide profit range.

Straddle your way to profits
Another way to squeeze profits from a stock is to write a straddle. The concept is the same as the strangle that we just explained, but here you use the same strike price on your calls and puts.

You generally use this strategy if you believe a stock is going to be less volatile over time, staying in a tight price range.

For example, Netflix (Nasdaq: NFLX  ) was up more than 80% last year. If you believe the stock is due to settle down, but you'd be happy to buy more shares cheaper or sell your shares higher, you could straddle the $53.30 shares with options today (this trade is ideal when the stock is right near an option's strike price, but here it's just $0.80 higher). Take a gander:

Selling Puts

Netflix

Selling Calls

Combined Options

March $52.50 puts pay you $3.60

$53.30

March $52.50 calls pay you $4.60.

$8.20 payment to you, or 15% of the stock price

Compared to a strangle, the straddle has much higher odds of resulting in a stock transaction, since you're using strike prices that nearly equal the current share price. If Netflix is below $52.50 by March expiration, you get to add to your position. Your effective net buy price would be $44.30. If Netflix is above $52.50, your existing shares would be sold, resulting in a net $60.70 sell price including everything the options paid you.

However, if Netflix is anywhere above $44.30 and below $60.70 by expiration, you can close your options for a partial profit, and keep your shares with no other obligations. That's another wide range for profits. Finally, if Netflix ends the expiration near $52.50, you'd make most of the $8.20 closing your options early.

Or, if you owned a position in Buffalo Wild Wings (Nasdaq: BWLD  ) , the $40 stock offers a June $40 straddle that pays $8.80 right now. Would you be happy to buy more shares at a net $31.20 or sell your existing shares at $48.80? Or just make option profits as long as the stock is within this range? Bull or bear, it gives you plenty of room to earn option income. Other stocks with options that pay well include GlaxoSmithKline (NYSE: GSK  ) , Hasbro (NYSE: HAS  ) , Under Armour (NYSE: UA  ) , and Apple (Nasdaq: AAPL  ) .

Strangles and straddles summed up
To use a strangle or straddle strategy, you have to own at least 100 shares of a stock, you have to be willing to buy at least 100 shares more, and you have to be ready to sell your existing shares.

So, while the media and most investors obsess over the market's next move, you can set up strategies that will profit whether it's up or down. And if stocks stay in a range, as they eventually will following this record ascent, you'll be ready to keep right on profiting anyway.

Profiting no matter what the market does is our specialty at Motley Fool Pro. If you'd like to see what we're recommending people do now, just put your email in the box below to learn more. You'll also get a special report -- "Options 401: How to protect your gains in an uncertain market" -- absolutely free.

Jeff Fischer is advisor to Motley Fool Pro, where these strategies are put to use with the Fool's real money. He doesn't hold positions in companies mentioned. Under Armour is a Motley Fool Rule Breakers selection. Apple, Hasbro, and Netflix are Motley Fool Stock Advisor recommendations. Buffalo Wild Wings and Under Armour are Motley Fool Hidden Gems recommendations. The Fool owns shares of GlaxoSmithKline, Hasbro, and Under Armour. The Fool's disclosure policy profits in every market.


Read/Post Comments (8) | Recommend This Article (20)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On January 12, 2010, at 2:20 PM, langco1 wrote:

    with the US now in its second year of a depression 2010 will go down in history as the year of the bankruptcy...

  • Report this Comment On January 12, 2010, at 4:19 PM, jrod87 wrote:

    Who’s going bankrupt? Im working two jobs now to pay of all my credit card debt. I would hope that hard working Americans do what they need to do! Pay off debt and Save YOUR money. Let the corporations, credit hungry consumers and banks go bust not you or your family.

  • Report this Comment On January 12, 2010, at 4:26 PM, dysonn wrote:

    This article sounds like an advertisement for a get quick rich scheme. Please mention the risks (i.e. if the stock price moves significantly).

  • Report this Comment On January 12, 2010, at 5:34 PM, rfaramir wrote:

    I learn more here all the time! I'd heard of straddles and strangles but they were just jargon. Now it's becoming clear.

    I agree with dysonn that a bit of clarity on the full range of risks would be nice. These sound like wins within a trading range, but how bad is it outside that range?

  • Report this Comment On January 12, 2010, at 10:14 PM, xetn wrote:

    Jrod87:

    "Let the corporations, credit hungry consumers and banks go bust not you or your family."

    This seems a little stupid to me. Do you work for a corporation? Are you an investor in corporations that you wish to profit from? If you are paying off debt, were you not a "credit hungry consumer"?

    I guess the only corporation you don't want to go bust is the one you are working for? I guess the only corporations you don't want to go bust are the ones you are investing in?

  • Report this Comment On January 12, 2010, at 10:31 PM, goalie37 wrote:

    Motley Fool is now pushing options? Oh well. It had to end eventually.

  • Report this Comment On January 12, 2010, at 11:11 PM, TMFFischer wrote:

    Greetings,

    Motley Fool has been using options Foolishly (and publicly) since 2008. It has two services -- Motley Fool Pro and Motley Fool Options -- that educate about them and make options recommendations to members. The performance has been admirable. I've been using options for about a decade.

    The risks with writing covered straddles and covered strangles is no different than the risks in writing covered calls or cash-secured puts.

    If the underlying stock soars, you're selling away the shares you own via your calls, for a profit. You miss upside if it soars above your range. If the stock falls enough, you'll buy more shares via your puts, for a considerably lower net buy price given what the straddle or strangle paid you. So, you just need to be ready to buy more shares if they fall sharply (and then wait for a rebound), or sell your existing shares if they go higher than your range, selling for a profit.

    The nice thing about writing good covered straddles or strangles is that they'll have you buying more shares cheaply, or selling your existing shares at a good sell price -- or simply earning good income if the stock stays in a range.

    Best,

    Jeff, Motley Fool Pro and Motley Fool Options

  • Report this Comment On January 13, 2010, at 8:39 AM, kayakmastr wrote:

    Jeff is right on target with a conservative options strategy! The strategy provides additional returns, and the risks are no greater than buying and selling stocks directly. I increased my returns in 2009 by over 30% using this strategy. In selling covered calls, you only risk missing out on a price increase that you didn't expect. So I don't see that as a risk. In selling puts, you risk having to buy a stock at a lower price than the current price. If this stock is one you want to own and hold anyway, because you expect it will appreciate, that doesn't seem to be a risk either.

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