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Replies to post #135986 on Biotech Values
We have long advocated using a simple options strategy to increase returns and reduce risk. Called the buy-write, or overwrite, strategy, it entails selling an out-of-the-money call against a stock that you simultaneously buy, or already own. For an investor whose performance mirrored the market's last year, using this strategy last year would have generated gains of 6% to 8%, compared zero.
A major study titled "Beat Your Benchmark" was just released by Goldman Sachs. It analyzes the strategy's performance over the 16 years through 2011. The firm's derivative's strategists, John Marshall and Katherine Fogertey, found the strategy was the difference between dramatically beating the S&P or not. Their study improves upon some academic ones by taking into account actual trading conditions and transaction costs.
Many investors sell bullish calls when stocks they own are about to report quarterly earnings. The researchers, however, find that stocks often react more sharply than reflected by options prices, which means investors often aren't paid enough for selling the option.
The key to significantly outpacing the market seems to be selling calls against large-capitalization stocks with high implied volatility (the critical part of an options price) during months in which the company isn't reporting earnings. Doing this, Goldman reports, boosted annual returns by 5.39 percentage points from 1996 to 2011, and reduced risk.
Over the longer term, the results weren't so dramatic, but they were certainly noteworthy, at least cumulatively. Marshall and Fogertey write that monthly sales of 10% out-of-the money calls on liquid stocks in the S&P 500 added almost a quarter-point of outperformance to the index's returns over the past 16 years. Overall, they add, an overwriting strategy outstripped the S&P in 10 of the 16 years, including 2011.
Naturally, some years are better than others. When stock prices are surging, selling calls against shares can hurt performance; it limits profits, since the stock must be sold if its price exceeds the call's strike price.
Ideal conditions exist when the stock market is moderately advancing, and options prices are high, as in 2000 to 2002, and 2006 to 2008. The study found those periods were the strongest for the strategy in the 16 years examined.
HOW CAN THIS STRATEGY be implemented now? By selling February calls that are 10% out-of-the-money in Range Resources (ticker: RRC), Salesforce.com (CRM), Southwestern Energy (SWN), Nabors Industries (NBR), Transocean (RIG), Weatherford International (WFT), Dish Network (DISH), Mosaic (MOS), Red Hat (RHT), Lululemon Athletica (LULU), Alcoa (AA), Marvell Technology (MRVL) and American International Group (AIG).
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