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How to Profit & Protect the S&P 50 with Options in this Overbought Market


Thursday was another great day for the bulls on Wall Street, and another great opportunity to get short for me, as I believe this market is well overbought on the short term. The market sold off a bit going into the close, my guess is because some were taking profits before the GDP numbers. The stock market major indices are up huge since July 1, 2009; Dow Jones Industrial Average up 8.38%, NASDAQ up 8.13%, and the S&P 500 up 7.33% (click chart to enlarge).

However to reiterate myself from a previous blog post on, this market could continue the rally with better than expected earnings, and a "less worse" economic outlook. There is still a ton of money on the sidelines gaining almost nothing, that could be put to work in the market. However I don't think a 5% short term correction is out of the picture. I am being extremely cautious committing new capital to the market at these levels, but one strategy I am using to get into this market is the Buy/Write option strategy. The buy/write option strategy allows me to get into the stocks for less than current levels, with provide me with a positive returns if the market continues to rally, and give me protection is the market sells off from the current level. In this post I will outline the top 50 companies (by market cap) in the S&P 500 index, and will provide a buy/write option strategy for each. Therefore, to understand this post you'll need some knowledge of stock options. To learn more about this strategy and stock options in general check out my blog or book here.

For this analysis I used the S&P 500 list of stocks spreadsheet I created, to generate the top 50 stocks by market cap with the click of a button. To download this spreadsheet click here.

All data as of market close Thursday July 30, 2009.

The stocks are in order from greatest to least market cap. The first stock in the table below is Exxon Mobil (NYSE:XOM) to understand how to read the table I'll give a worded example using Exxon Mobil. The example assumes the stock was being purchased and immediately written out for the August options expiration.

Purchase Exxon Mobil (XOM) stock, and sell the in the money August 70 strike call option. The premium received from the call option would give a downside protection of 2.47%. If the stock is assigned at options expiration on August 22, 2009 the total return from this position would be 1.46%. The August options expiration is 22 calendar days away, so it may be best to monitor the position and buy back the call option on weakness of the underlying stock, if the stock rallies after it is purchased back, write it back out for a higher premium.

Company Ticker Strike Premium Return% Protection %
Exxon Mobil Corporation  XOM  70 1.75 1.46 2.47
Microsoft Corporation  MSFT  23 1.11 1.26 4.66
Wal-Mart Stores, Inc.  WMT  47.5 2.64 0.32 5.28
Johnson & Johnson  JNJ  60 2.22 0.70 3.59
The Procter & Gamble Company  PG  55 2.1 1.55 3.73
International Business Machines Corp.  IBM  115 4 0.97 3.39
AT&T Inc.  T  26 0.76 1.59 2.89
Apple Inc.  AAPL  160 6.05 2.00 3.72
JPMorgan Chase & Co.  JPM  37 2.14 1.74 5.56
Google Inc.  GOOG  430 21.3 1.27 4.78
Chevron Corporation  CVX  65 3.45 1.11 5.10
General Electric Company  GE  12 1.28 1.30 9.76
Cisco Systems, Inc.  CSCO  21 1.29 1.41 5.87
Bank of America Corporation  BAC  13 1.21 1.72 8.66
Wells Fargo & Company  WFC  24 1.4 2.13 5.63
The Coca-Cola Company  KO  47.5 2.4 0.46 4.83
Oracle Corporation  ORCL  21 1.33 0.86 6.01
Intel Corporation  INTC  19 0.66 1.71 3.41
Pfizer Inc.  PFE  15 0.99 0.31 6.21
Hewlett-Packard Company  HPQ  42.5 1.55 3.14 3.63
Philip Morris International Inc.  PM  46 1.55 1.56 3.31
Verizon Communications Inc.  VZ  31 1.53 0.68 4.74
PepsiCo, Inc.  PEP  55 2.17 1.01 3.83
Goldman Sachs Group, Inc.  GS  160 5.95 2.17 3.66
QUALCOMM, Inc.  QCOM  45 2.16 1.38 4.64
Abbott Laboratories  ABT  44 2.15 0.98 4.70
ConocoPhillips  COP  42 1.97 1.81 4.56
Schlumberger Limited  SLB  50 4.25 1.53 7.95
Merck & Co., Inc.  MRK  29 1.55 2.04 5.18
Amgen, Inc.  AMGN  60 4.2 1.73 6.66
Wyeth  WYE  45 2.03 0.73 4.35
McDonald's Corporation  MCD  55 1.4 1.46 2.52
Occidental Petroleum Corporation  OXY  70 2.7 2.99 3.82
United Parcel Service, Inc.  UPS  55 0.73 3.94 1.36
CVS Caremark Corporation  CVS  32.5 1.7 1.82 5.06
United Technologies Corporation  UTX  55 0.98 3.23 1.81
The Walt Disney Company  DIS  25 1.78 2.14 6.79
3M Company  MMM  70 1.5 2.29 2.15
Monsanto Company  MON  85 2.55 3.70 3.02
Gilead Sciences, Inc.  GILD  49 1.55 1.96 3.13
The Home Depot, Inc.  HD  25 1.37 2.01 5.30
Schering-Plough Corporation  SGP  26 0.93 1.62 3.51
Comcast Corporation  CMCSA  15 0.67 4.33 4.46
Bristol Myers Squibb Co.  BMY  21 0.9 1.58 4.17
Kraft Foods Inc.  KFT  28 1.15 2.03 4.03
Eli Lilly & Co.  LLY  35 0.63 1.65 1.80
Medtronic, Inc.  MDT  35 1.08 2.04 3.05
U.S. Bancorp  USB  20 0.92 2.15 4.49
Colgate-Palmolive Company  CL  70 2.7 1.21 3.76
Morgan Stanley  MS  28 1.22 3.03 4.30

As the Volatility index is creeping back up, call option premiums should increase in value overall, protecting and giving an even higher return. I use this strategy to write my shares out on strength, and purchase them back on weakness (if I am profitable). For example: using this strategy has allowed me to cost average my position on Caterpillar (NYSE:CAT) down to $4.88 a share. Patience is key to succeed with this strategy. If the stock gets called out, and you miss the upside, the position is still profitable and you can always do it again for the next options expiration. If the stock gets hammered and you're down on the position, this strategy will keep you in the game and allow you to cost average the shares down month after month.

All of these options expire on August 22; therefore the last trading day is Friday, August 21, 2009.

These are just examples and are not recommendations to buy or sell any security; if you're more bullish/bearish, you’ll want to adjust the strike price and expiration accordingly.

This strategy will give protection if the market sells off, as well as provide a return if the market continues to rally. If the stock is not assigned, this strategy is a great way to create additional income for your portfolio. The reason option volumes have surged in the last 5 years is because they are a great way to hedge your portfolio as well as create income off of your shares (see chart here). Keep in mind when using this strategy it is essential that broker commissions are low enough to profit from the position.

Disclosure: Long BAC, CAT, GOOG, GS, PFE