Quite a large number of investors use buy-write strategies in options. The strategy is relatively simple. You buy a stock and sell a call against it. If the stock goes down, you at least have the value of the call to cushion your losses. If it goes up, you gain up till the total of the strike price plus the price of the option. So this is a way of somewhat limiting you risk and gaining additional income beyond the stock's dividend. Studies have shown that buy-writes do in fact have pretty good risk-reward characteristics.
But there's a way to do even better: the put-write. In fact studies have shown that put-writes do even better than simply going long the market. Sounds good, so what is a put write? It works like this: you decide on a strike price for a stock you like. Usually this is done at a strike slightly under the current market price, but there's no hard rule here. Than you figure out the amount of money it would take to buy the stock at that price, which of course depends on your position size. You put that money in a safe asset, something like T-bills. Then you write the put. If the market goes up, the put expires worthless and you pocket the premium. If it goes down, you get exercised on the put, and you own the stock at that price. If so, you then turn around and sell it and write another put.
Some of you who are experienced options traders may see something fishy here. You may know that writing a put is exactly the same thing as being long the stock and writing a call (a buy-write) at the same price. So what's the big deal about put-writing? The answer has to do with something called the "skew." Almost always, lower striked stock options are more expensive than higher striked ones. This is because most people are scared of big bear markets and are willing to pay up for out of the money puts. The difference can be substantial, especially now that market participants still have 2008 in their minds. For example, Right now SPY is trading for about 136. The 90-day 140 call is 2.25, but the 132 put is 3.72! Over a period of years, this makes a big difference. In fact, look at this graph of total return for buying SPY, doing a buy-write on SPY or doing a put-write.
Note that the put-write strategy has more than made up for the losses of 2008. Here are some tips I use for the strategy:
1. I usually write 3-month options
2. I like to write puts less that one standard deviation below the market.
3. I keep a watch on the skew. If puts stop being cheap I would stop the strategy. I don't expect this to happen anytime soon.