Selling Options

For past one year I have traded both puts and calls - but always from a long perspective. In other words - I only purchased the options contract primarily as a means for speculation and not for investment purposes.

Tonight I am going to briefly discuss the opportunities that are available through selling options. There are two main entry level strategies for selling options:

1) Selling calls (covered by underlying stock) - with this strategy you collect a premium in exchange for selling the right to someone else to buy your stock at a certain price. Basically this will limit your upside - but in a down or sideways market it may help to reduce your cost basis in the stock by allowing you to collect more options premium.

2) Selling cash-secured puts (covered by cash) - with this strategy you collect a premium in exchange for selling the right to someone else to sell the stock to you at a certain price. Basically this strategy is a more aggressive way to lower your cost basis in the stock. Premiums are often higher than the call premiums and you do not have the limited upside problem of selling calls. The obvious negative is that you are on the hook for the entire downside. Still as you are trading cash secured - I would argue that it is no different than if you were holding an equivalent amount of shares - you are still vulnerable to a major Enron type situation that could otherwise be controlled by diversification, etc. - but you are gaining the advantage of lowering your cost in the stock the majority of the time.

Bottom line is that I think both of the above strategies are better suited to an investment approach than a speculation. Coincidentally I also happen to have some more conservative investment type value plays to go with. Who? What sector? The chemicals. I am not sure if they have hit the bottom in this down cycle or not - it is probably heavily contingent on oil pricing, etc. - but they are near 52-week lows.

One potential candidate is Georgia Gulf Co. This one is trading around $26.74 right now with 52-week low in the $21 range and 52-week high in the $46 area. The specific strategy would be to sell November 2006 puts at the $30 strike price - probably 3 contracts for $5 each. I would collect $1500 of premium. I would also concurrently purchase 300 share of the common stock - or maybe if I am feeling more speculative I could purchase 6 calls at the $30 strike price for $2.25 each, for a total of $1350.

Anyways - here is the chart:

I almost - forgot - I should give a little more detail on the fundamentals behind this play. First off - this is a chemicals company and is heavily dependent on energy in order to make its product - large amounts of energy - like oil and natural gas which has been extremely expensive over the past few years.

If you look at the chart - GGC happened to hit its 52-week low - last fall right after Katrina when oil and natural gas went through the roof. That is no coincidence in my opinion as I believe that there is a negative-correlation between the two. Bottom line - I think the commodities bull is getting long in the tooth intermediate term and I see gold, oil, and silver complex selling off this year. When? I don't know - maybe gold has to hit $650 first and oil $90 first -we will see. I am keeping a close eye on this sector though. It is beaten down and this stock in particular could have a hell of a relief rally back into the high 30s if the oil price comes off even $10-15 like it did in the spring.

I am just planning on executing the transaction with a new twist this time - the PUTS sale. Execution time frame - probably in next couple months. Execution target area - here would be OK, but I would prefer right around the 52-week lows.

Best regards,

BG