The VIX has popped from its lows as it was unable to break below 20% while the Credit Suisse Fear Barometer has hit levels not seen since June of 2008. Many are questioning whether this reversal is the onset of a massive correction that is long overdue, or simply the market taking a breather before making new highs. Depending on your outlook, now is a good time to take advantage of the option markets to express your view.
Slightly Bullish Outlook:
Take advantage of a covered call options. The markets have retraced 60% since the bottom in March and stocks appear that even with the most optimistic earnings assumptions that prices are more than fair valued. Look to sell call options on the stocks that you own with expirations 3-6 months and strikes that slightly out of the money (5-10%). This allows appreciation if the stock makes a move higher while providing some premium if the market stands still or retraces a bit.
A Correction is on the Horizon:
Use the covered calls as you would in the bullish scenario, but sell the call options 5-10% in the money. This position can protect you on a loss of up to 10% and you can capture a premium above and beyond selling the stock outright.
We are Going to Hit the March Lows Again:
Forget about covered calls, you need more protection. Sell a call slightly out of the money (3-5%) and buy a put 5-10% out of the money. This is a collared position and the written call will partially pay for your long put (protection) position. With this type of position you are able to sell some implied volatility in the call to subsidize the implied volatility you are buying in the put option.