Some people are fortunate enough to own a large position in one stock. Large positions are known as concentrated equity positions and may have been accumulated from working for one corporation for years and acquiring company stock. Maybe the large position was obtained through an inheritance.
It may seem that having a substantial sum of money in a stock couldn’t be much of a problem. But, if you do have a large percent of your net worth tied up in just one company and don’t want to sell the stock, but desire to produce more income from it or protect the position during a period of market turbulence, there are some strategies you can consider.
For those who want more income you can sell call options against your current holdings to produce some cash flow. One disadvantage to the covered call strategy is that your upside potential is limited.
There are alternatives if you don’t want to limit the upside potential of your holdings — one is to only write calls on a part of the position, and another is to use a credit spread instead.
A credit spread consists of short and long calls at different strike prices for those clients who don’t want their upside gain limited too much, but still want to produce some extra income.
Investors concerned about downside risk can use a collar, which consists of selling calls and using the premium collected to buy puts to protect your position from loss.
Upside gain is sacrificed to achieve downside protection. The collar can be set tight or loose depending on your goals. A collar can be so tight that there is no risk at all in the position, but if there is no risk, there is little possibility of reward.
The collar can be looser to allow some upside potential, but then you’ll also have to take on some risk — but that risk can be defined by the strike price of the put option that is selected.
Also, investors can collar only part of their position for protection and leave some un-collared so it still has unlimited upside potential.
Investors who want downside protection without sacrificing upside gain can purchase put options. Buying puts is like buying insurance on your house; it will cost you some money and you hope you don’t need it, but if the house burns down, you’re glad you have it.
Kenneth Roberts is a Truckee-based Registered Investment Advisor. Information on his money management service can be found at his blog at www.sellacalloption.com or by calling 775-657-8065. Past performance does not guarantee future results. Consult your financial adviser before purchasing any security.