Uncle Bill

Options Trader: Plays on Dow Components

Writing LEAP puts? About 2/3 of option premium is expected to waste away during the last six weeks of an option's life. By selling so far away, you never get the advantage of that premium erosion. Your gain is limited to the amount of the put you've sold, while your loss is limited only by the price of the stock. You're essentially betting on the direction of the stock, and you've capped your upside gain in order to invest more money in the strategy than if you just bought the stocks on margin. If the market falls dramatically one day while you're holding these puts, you'll lose all the money you've made since '02. The best way to avoid this is to sell puts on stocks that already have fallen more than two standard deviations below their mean prices. Also, don't employ this strategy once the market itself has moved more than two standard deviations above its mean price. If the market falls after an extended rise, your short puts will get killed by volatility expansion too. This is a very dangerous strategy in this market environment.