Here are two main reasons many investors don't use stock options:
- Options can seem complicated.
- Advanced options strategies might require special permission from your broker.
I'm not going to pretend that options can't be complex, but, like anything else, options are only as complicated as you make them. The good news is that more complicated options strategies don't imply fatter returns. Sometimes writing puts (a simple options trade) can put a juicy chunk of change in your pocket while your know-it-all neighbor's iron condor (a complicated options strategy) gets shot out of the sky.
While most brokers must grant permission for advanced options trades, most investors can easily obtain basic options trading permission. With this in mind, I offer four simple options trades that almost anybody can make today.
1. Write puts on Johnson & Johnson
Health-care juggernaut Johnson & Johnson (NYSE: JNJ) is a stumbling elephant, but one that should be able to right itself before too long. The company pulled in $62 billion in revenue last year, with 70% of that coming from products that are either the global leader or runner-up in their space. But it's not Johnson & Johnson's $14 billion in free cash flow last year that made headlines. Instead, the focus has been on a slew of product recalls and patent expirations, and the stock price took a hit as a result. The stock has rebounded slightly since then, but at just 14 times free cash flow, shares remain cheap for as high-quality a company as Johnson & Johnson.
The recent volatility in this normally staid stock has also driven up premiums on its options. Today, you can write July 2011 $67.50 puts for a $1.42 premium. If the shares are over $67.50 on July 15 -- just over a month from now -- you keep the $1.42 per share, which translates to 25% annualized return. If the stock is under $67.50 at expiration, you end up with shares at the attractive net purchase price of $66.08 per share.
2. Write covered calls on Activision Blizzard
World of Warcraft creator Activision Blizzard (Nasdaq: ATVI) sports a stock that is cheap by a variety of metrics, but it's been cheap by all those metrics for quite a long time. The underlying business continues to grow by leaps and bounds, with earnings up a whopping 375% since just 2009, but the stock has actually fallen 35% since Activision and Blizzard merged in October 2008. This stock certainly has plenty of room to run, but to milk more short-term return on these shares (which yield a measly 1.5% in dividends), consider writing covered calls.
The August 2011 $12 calls in particular look attractive: If shares are below $12 in August, you keep the $0.34 option premium (a 19% annualized yield at today's share price), then you can repeat the same trade with a later expiration. The downside to this trade is that you would limit your upside if the stock were to go on a tear in the next two months. But if you think that is likely, you can simply buy the stock or consider writing calls on just half of your shares.
3. Buy LEAPs on Intuitive Surgical
Investors in Intuitive Surgical (Nasdaq: ISRG) have been richly rewarded to date: The stock is up 200% over the past five years and 1,800% over the past decade. That's because of the growing acceptance and popularity of the company's robotic-arm surgery system, which was initially designed for prostatectomies and now handles an ever-widening range of surgeries. By traditional valuation metrics, Intuitive Surgical is far from cheap, but when you lay the market potential of this disruptive business against the company's $13 billion market cap, the company has plenty of room to run.
If you believe in the market opportunity, one strategy is to buy LEAPs (long-term equity anticipation securities), which are call options with long-dated maturities. For $57.05 per share, you can buy January 2013 $350 LEAPs. The stock must close above $407.05 in January 2013 for you to break even, but anything above that is a leveraged gain. At $500 a share, for example, the return on the LEAPs would be 163%, versus 46% if you just bought shares today. And in case of a downturn, your loss is limited to the $57 you paid for the LEAPs.
4. Write puts on Intel
If you are reading this from a computer, the chips powering the system are probably from Intel (Nasdaq: INTC). But if you are reading this on a mobile device, there's a good chance the chips are not from Intel. That, in a nutshell, is why Intel's shares have languished of late. But just because Intel didn't make the first move in mobile doesn't mean it won't be a big player. After all, Intel spends 10 times more on R&D annually than top mobile chip competitor ARM Holdings (Nasdaq: ARMH) does in sales. Even better, put options on Intel's shares are paying nicely. The August 2011 $21 puts offer $0.69 per share, offering a 20% annualized yield if you are not forced to buy the shares. If you are forced to buy the shares, you end up with a cost basis of $20.31 per share; at that price, Intel's dividend yields you 3.5% while you wait for shares to appreciate.
Start simple, then work your way up
Options needn't confuse or intimidate investors, especially when even simple strategies can offer investors attractive opportunities. Of course, the more familiar you become with options strategies, the better you equip yourself to profit from almost any market situation.
For more ideas -- including more complex strategies, if you want them -- and education every step of the way, you might want to consider joining Motley Fool Options, which is opening for a limited time. For more information on Motley Fool Options, including an entirely free trial, simply drop your email in the box below. Happy options investing!
