CommSec Market Analyst Steven Daghlian speaks with Omid Shakibaei CommSec Exchange Traded Options DTR about the Combination Buy Write strategy using Telstra as an example.
CommSec Options Report: 11 May 2017 Combination Buy Write
In this note we will revisit a strategy that we haven’t written about for nearly 12 months - The Combination Buy Write. Unlike a conventional Buy Write, where you only sell out of the money Calls, in this strategy you also sell out of the money Puts. So in effect, you are selling a Strangle around your shareholding. The strategy is normally employed to take advantage of higher than normal Implied Volatilities, which leads to higher ETO prices. The view is that by selling a Strangle around the initial shareholding, you are enhancing the Buy Write return, which coupled with an attractive Dividend Yielding stock, may lead to solid income returns. Further, the strategy may be appropriate for investors who consider that the underlying security already represents value, but given they are short a Put, are comfortable being assigned and adding to their existing shareholding at those levels. Hence the Combination Buy Write is mostly appropriate for the more sophisticated investor with a higher risk tolerance given the downside exposure is effectively doubled in a large negative move. Clearly the ideal scenario with this trade/strategy is to profit from a sideways to slightly higher share price. As an example case we will use Telstra to illustrate the payoff diagrams and how the above trade enhances yield. Telstra is a classic example of a High Yielding stock. And now with the uncertainty out of the way regarding the regulators ruling 5 May 2017 on mobile roaming, investors can have a little more certainty around its shorter term earnings prospects. However, Telstra still faces competition, as evidenced by TPG’s right to purchase a mobile spectrum, which may well cap any upside moves in the short term, yet the Dividend Yield is attractive to many income seeking investors at current levels, versus current domestic cash rates - and this may well continue to provide support for the stock. Therefore, as a result Telstra may well be range-bound for the foreseeable future. If that’s the case, the above ETO strategy could be employed, as the returns - coupled with the current Dividend Yield - can mean a significant overall income is attained. Obviously we have just used Telstra as an example case on how this strategy works and what the payoff looks like, but there are many stocks that this same strategy can be applied to. If you think that such a strategy is suitable for you, please ensure that you consult your financial adviser and take into account your current financial circumstances.
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