Back to the Basics: How to Get Started Trading Options

It can be intimidating at first.

Delta, theta, gamma, vega…options are clearly more complex than just buying a stock or ETF that you think will go up. But the rewards and diversification opportunities of learning options is worth it. After some time, many traders feel as comfortable with options as they do stock. What are some of the ways we could use options in a diversified portfolio?

1. Risk management. The most basic form of using options is to buy puts as a hedge for long stock. You’re long a stock or ETF that you are bullish on, but you also want to protect yourself against large unexpected losses. Buying a put gives you the right to sell your holding at a certain price for a certain length of time in exchange for a premium. This is very similar to insurance.
    
2. “Income” generation. In order for someone to buy a put to protect their position, someone must be willing to sell them that contract. For this reason, option contracts are known as a zero-sum game. Interestingly enough, it’s possible that both parties have the same bullish view on the underlying asset. The put buyer may be hedging his long position and is better off if his hedge expires worthless. The put seller may be bullish on the underlying asset but wants to acquire it at a lower price or simply gain exposure in a less directional way. Selling puts is my favorite overall method for using options, as it has positive expected returns over the long-term with less downside exposure than owning the underlying asset outright. Of course the trade-off is that your upside is also limited. There are always trade-offs.
    
3. Speculation. A put buyer could also simply believe the underlying asset is going to decline and buying a put may be an easier way to express a bearish view on an underlying asset than shorting it. It also limits losses to the premium paid, whereas shorting can have theoretically unlimited losses.

These 3 examples outline simple ways to use puts. There are many similar ways to use call options as well, with the most basic and popular method being covered calls (which is similar to selling puts) and then even get into the complexity of spreads. Option spreads are created by combining multiple long and short option positions. So, with all of this in mind what’s a simple way to get started? As I said, I like the idea of selling puts, and that’s what we do in our Steady Momentum PutWrite service.

Each month, with overlapping positions meeting our target exit criteria on a regular basis, we sell slightly out of the money put contracts on equity market indexes such as the S&P 500, Russell 2000, and MSCI EAFE and collateralize the contracts with short and intermediate term bond ETF’s. This gives us exposure to thousands of stocks across the world, as well as exposure to the credit and term premiums in the bond market. By overlaying short puts on a bond ETF portfolio we create “portable beta”, which is a technique that creates leverage.  I’ve written multiple articles about the overall strategy, which you can find here.  
 

The Steady Momentum PutWrite strategy is the most conservative strategy available for subscription on the Steady Options website, and is relatively simple to follow. This makes it ideal for traders of all kinds, but especially those new to the options markets. In my article, I share examples of how put selling might have performed over the last several decades based on publicly available data from the Chicago Board Options Exchange (CBOE) to help set proper expectations and to provide subscribers with confidence. 

I also professionally manage this strategy for clients of my firm, Lorintine Capital, which I co-own and operate with my business partner Chris Welsh. You can read more about managed accounts here. The investment minimum for Steady Momentum PutWrite managed accounts is currently $100,000, but as a self-directed subscriber where you manage your own account, you can start with less. If you’d like to learn more about the strategy, please subscribe HERE. For questions related to managed accounts, please feel free to contact our office at 214-800-5164.

Jesse Blom is a licensed investment advisor and Vice President of Lorintine Capital, LP. He provides investment advice to clients all over the United States and around the world. Jesse has been in financial services since 2008 and is a CERTIFIED FINANCIAL PLANNER™ professional. Working with a CFP® professional represents the highest standard of financial planning advice. Jesse has a Bachelor of Science in Finance from Oral Roberts University. Jesse manages the Steady Momentum service, and regularly incorporates options into client portfolios.

Related articles:

• Combining Momentum and Put Selling
• Trend Following: An 88 Year Look at the S&P 500
• The Scientific Process of Increasing Expected Returns