This article is part of our series on options investing, in which the Motley Fool is sharing a number of strategies you can use to get better results from your investment portfolio.
If you've never used options in your investing, it's probably for one or both of these reasons:
- Options can seem complicated.
- Advanced options strategies might require special permission from your broker.
I don't pretend that options can't become complicated, but, like anything else, they are only as complex as you make them. The good news is that, just as in other aspects of investing, there are no bonus points for complexity. Often, writing puts (a simple options trade) can put a nice chunk of change in your pocket while your know-it-all neighbor's iron condor (a complicated options strategy) is shot out of the sky.
More good news: While most brokers are hesitant to grant permission for advanced options trades, most investors can easily obtain basic options permission from their brokers.
With that in mind, I offer up three simple options trades on familiar companies that almost anyone can make today.
Write puts on Microsoft
Companies don't come much more familiar than Microsoft (Nasdaq: MSFT ) ; I'm typing this article on a version of Microsoft Word. As ubiquitous as its products are, the software behemoth's stock price has been stuck mostly in the mid-20s for the better part of a decade, even as revenue has climbed more than 175% over that time. At just 6 times EV/EBITDA, shares today are looking cheap -- and they now come with a 2.5% dividend yield.
If you are hesitant to park cash in this recently range-bound stock, consider writing puts. The December 2011 $25 puts are currently paying $1.37, which comes out to a 5.5% return in just over three months. If shares are below $25 in December, you'll purchase the stock at an effective cost basis of $23.63; if not, you'll simply pocket the premium. If you like both possible outcomes, this could be a good trade for you.
Write covered calls on Activision Blizzard
Video game juggernaut Activision Blizzard (Nasdaq: ATVI ) sports a stock that is cheap by a variety of metrics -- and has been for years. The underlying business continues to grow by leaps and bounds, but the stock has actually fallen more than 30% since Activision and Blizzard merged in 2008. This stock certainly has plenty of room to run, but to milk more short-term return on these shares (which yield a measly 1.4% in dividends), consider writing covered calls.
Covered calls involve selling calls on a stock you own, so this trade would involve buying the shares and then writing the calls. With the stock currently trading for $11.61, the November 2011 $12 calls, currently selling for $0.52, look attractive. If Activision trades below $12 in November, you keep the $0.52 per share (a 4.5% return in just over two months). If Activision trades above $12 in November, you must sell your shares for $12 -- but you still keep the $0.52, which means your effective sell price is $12.52, or just shy of an 8% return in about two months. The bigger risk here isn't that you'll lose money; it's that you could miss out if the stock suddenly took off, since your short-term upside is capped at that 8%. You'd be sacrificing the possibility of a short-term outsized return for a capped but more secure return.
Buy LEAPs on Berkshire Hathaway
It's no secret that Berkshire Hathaway (NYSE: BRK-B ) is trading at a historically cheap valuation. With shares going for just 1.1 times book value, the market apparently doesn't expect much -- anything, really -- from Warren Buffett's brainchild going forward.
That is, frankly, ridiculous. The company's operational footing is as strong as ever, and with more than $40 billion in cash, you can be sure Buffett is making his own opportunistic bets these days (such as his recent deal with Bank of America (NYSE: BAC ) ). Even using what I consider to be conservative assumptions, I find it difficult to value Berkshire at less than $105 per share.
That makes buying Berkshire at today's $68 share price an easy decision, but it also draws attention to the stock's January 2013 LEAPs (and the soon-to-be released 2014 LEAPs). LEAPs (that's Long Term Equity Anticipation Securities) are long-dated call options, so they give you the right to buy a stock at a certain price up to three years down the road. For Berkshire, take a look at the January 2013 $90 LEAPs, currently selling for just $2.84 per share. Those require Berkshire to rise 35% by 2013 to make money. That's quite a climb, but given how cheap Berkshire is right now, it's not unreasonable. And if shares climb more than that, the payoff quickly amplifies: If shares end below $90, you'd lose the full $2.84; but if they hit my $105 valuation estimate, the return would be north of 425%.
Since they require large price movements to be profitable, LEAPs shouldn't replace normal stock ownership. When they do pay off, however, the returns can be outsized, so in small doses, LEAPs might deserve a place in your portfolio.
Complexity is overrated. Options strategies needn't have seven different parts to be profitable investments. A dollar made from writing a covered call is just as valuable as a dollar made from a bear put ladder or other more involved options strategy. As you become more comfortable with options, by all means start delving into the esoteric. But if you are just getting your feet wet, start simple.
Stay tuned throughout our options investing series and get the strategies you need to earn more from your investments. Click back to the series intro for links to the entire series.