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Looking Ahead And Using Options To Generate Income

I am having a hard time believing that the equity rally that began in March of 2009 and continues to this very day will continue at the same feverish pace. More importantly, the headwinds that have always been out there will continue to do so and cause the markets to move in "fits and spurts" versus trends.

If you remember back to late 2011, we had upside moves of 10-20% in very, very short timeframes. Can this continue? It can if the markets are "still in love" with quantitative easing, austerity measures and centralized bailouts. But as a trader looking to always generate "absolute returns", the technicals give me reason to use certain option strategies at this very moment.

Let me explain. The SPX has reached a recent high of 1420. If we are going to continue to trend higher, we will have to take that high out and proceed to new "bull market highs". The recent break off of the 1420 level down to 1360 may just have been large enough for us to finally "fail" and not make a higher high. Currently, we are sitting at 1390 and if recent data is any indicator, we could be at new highs in a day. It could be a good economic report, shorts getting stuck or a fundamental event such as Bernanke saying QE "to the Nth degree".

Until we hear more QE or until technicals show me that we are breaking through to the upside, I am going to look at the rallies as an opportunity to generate returns. There are two option strategies that I use to generate returns when technicals and fundamentals tell me to.

The first is covered calls. Covered calls are an "income strategy" and by income, I mean the production of 1/2 to 2% per month of income based on the underlying holding.

The second strategy is purchasing long puts. These long puts, purchased in favorable locations can take some of the risk off the table that the long portfolio holds in overbought situations. An "umbrella insurance policy" can be as easy to implement as purchasing puts on the SPY ETF.

The bottom line is fundamentals and technicals are always updating and they are always causing us to refresh our trading plans. Maybe our ongoing analysis causes us to enter trades, maybe to exit trades and maybe to monitor or as I call it, "massage" the trade.

Happy Trading


Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.