Interesting essay in this week's Barron's on cc writing. The basic argument is that the option premiums are too low to risk the loss of the underlying.
I'll include just a chunk of the text to get the argument. The last paragraph is intriguing. Buy long term calls if you are bullish, goes the argument.
Selling options today is a dangerous game. With prices so low, especially on call options, investors aren't rewarded for their risk.
The Dow Jones Industrial average has ranged only about 10% from 10,000 for nearly three years. So there's little volatility to juice prices of options. Seasonality plays a role, too: Equity volatility tends to decline during summer months and increase in the fall, notes a recent Credit Suisse First Boston report.
Volatility -- the amount by which the underlying stock is expected to move over the life of the option -- is key to an option's price. And as it continues to creep lower, option premiums, or prices, also slide. (Also, call-option premiums have declined with interest rates, notes Scott Fullman of Swiss American Securities.) Wall Street's latest parlor game is discerning whether volatility is truly low, or actually high, looking back over time. Although volatility for the Standard & Poor's 500-stock index is down from recent years, it is equal to or greater than long-term historical averages of around 15%, compared with the range of 20% to 30% in the last half of the 1990s bull market.
In these deadly calm waters, desperate-for-yield investors are still stubbornly selling calls, giving up the right to appreciation in the stock price, for little compensation.
"People who sold calls in the 1980s and 'Nineties as conventional wisdom should significantly reduce call-selling today, because the prices aren't sufficient and they're trading away possible upside" in the stock price, says Kyle Rosen of Rosen Capital Management in Los Angeles.
What's so frustrating is that smart money, seemingly unconcerned about a big decline, isn't buying puts in large numbers, either. "Option volume is generally down across the board, so no one is placing big bets either way," Rosen says.
Stop selling calls before it's too late, he warns. "Option prices are so low, it defeats the whole purpose of the strategy. If you're selling calls against stocks you own, you trade away upside for little return and little protection."
Instead, he says, bulls should buy longer-term options, such as two-year LEAPS (long-term equity anticipation securities), on stocks or indexes they like. Similar to a mortgage, investors can lock in the purchase of these options while volatility is low. Bearish on a stock or index? Rather than selling calls, he says, buy cheap put options. |
