We don’t believe in a “buy and hold” strategy. We firmly believe that when long a stock it makes sense to turn the position into a Covered Call by selling an out-of-the-money Call against it. This allows traders to lower their cost basis and reduce breakevens. Tom explained, “If you can buy a product for less than it's worth you're going to be better off. You are giving yourself a better chance of success than someone that has to pay full price for the same item. How do you do that? Well it’s quite simple, you just give up some of your upside.” When selling Calls, traders can fully hedge by selling an equal amount of Calls to their stock, under hedge by selling less or over hedge by selling more.
Tom continued, “To take it one step further, what if I sold something in a separate product that was highly correlated? And what if one of these products had a higher Implied Volatility?” Apple (AAPL) has been in an uptrend since June. The issue is that when the December expiration was opened for trade the strikes were $5 apart. It is only recently that the $1 strikes in between have been added and they have much less open interest and therefore less liquidity. Implied Volatility (IV) is also low in AAPL. That means traders are receiving less when selling premium and selling less extrinsic value.
Alphabet (GOOG) has a high correlation (0.93) to AAPL. It is a high priced stock which makes it attractive for selling premium. That high price means Naked Calls would have a high margin and the Buying Power Reduction (BPR) would hit hard. An alternative would be to sell Vertical Call Spreads as a cross-product hedge. A table of how to hedge 10% of a 1000 long share position in AAPL using GOOG Call Spreads was displayed. The table included the expiration and DTE, strikes of the short GOOG Call Spread, credit received, max loss (per spread), GOOG Delta (per spread), theoretical AAPL Delta and amount of GOOG spreads needed to hedge at least 10% of a long 1000 share position in AAPL.
Tom noted, “You don't have to use GOOG for this. You can use something with tighter bid/asks like the liquid 1 point wide strikes of the QQQ which has a 0.75 correlation to AAPL.” Tom and Tony added, “You could do something funky like get long the Nasdaq and sell Russell Call Spreads against it. This will keep up your market awareness.”
For more information on Cross-Product see:
Closing The Gap from February 16, 2016: "Intra-Sector Strategies"
Market Measures from March 3, 2016: "Cross-Products Strangles"
Market Measures from October 11, 2016: "Cross-Product Strangles: IWM and DIA"
Watch this segment of Options Jive with with Tom Sosnoff and Tony Battista for the important takeaways and an explanation on how to use cross product defined risk option hedging in a correlated underlying to reduce risk and improve cost basis.
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