Options Trading Strategies - Lean

Professional traders use the term “lean” to refer to one’s
perception about the directional strength of the stock. When you
own a stock and intend to hold it for a period of time, you are
aware that you will probably be holding it while it goes up and
while it goes down.

This means that at any given moment in time, you might have a
different opinion of the potential movement of that stock.
Knowing this, there is a way to address your present level of
confidence or “lean.” You do this by your choice of which option
you sell.

While it is true that the at-the-money option has the most
amount of extrinsic value, it might not always be the ideal
option to sell in every situation.

For instance, if you feel that the stock itself has a very high
chance of producing capital appreciation above the potential
amount of premium you could receive from selling an at-the-money
call, then sell an out-of-the-money-call so you can allow
yourself a little more room to the upside on the stock.

For example, let’s say the stock is trading at $27.00. Normally,
you would sell the 27.5 calls at say $1.00. If the stock were to
rise quickly and eclipse the $28.50 mark, then with the
buy-write strategy, your position would have maxed out at
$28.50, and you would have a $1.50 one month gain. Not bad, but
if the stock went to $29.50 then you would have missed out on
another $1.00 profit. However, if we had sold the 30 calls for
$.30 then we would have another outcome. You bought the stock at
$27.00 and sold the 30 calls for $.30 and the stock goes to
$29.50.

You would have made $2.50 in capital appreciation and $.30 in
option premium for a total of a $2.80 return.

So, if you feel the stock has a real good shot at taking a run
up, you can lean your position long by selling an
out-of-the-money call.

If you have a more neutral view on your stock you would sell an
at-the-money-call in order to receive a bigger premium which
allows for greater downside protection if the stock trades down
and higher potential profit if the stock becomes stagnant.

This strategy also works on the downside. If, by chance, you
feel that the stock may trade down a bit during the life of the
option, then you can sell an in-the-money-call. The effect of
this would be to provide you with a little extra premium to
cover more downside risk.

Remember when you sell an option you seek to capture extrinsic
value. An in-the-money option not only has extrinsic value but
also some intrinsic value.

When you feel that you want to lean your covered call strategy
(buy-write) a little short, choose to sell an in-the-money call
so you can also have some intrinsic value to cover your
downside.

As an example, say your stock is trading at $29.00 and you feel
that your stock may trade down a little but still remain in an
uptrend cycle. You don’t want to get rid of the stock but you
also don’t want to lose any money so you sell the 27.5 call at
$2.00.

The stock starts to trade down and finishes at $26.00. If you
had owned the stock naked, then you would have lost three
dollars since you owned the stock at $29.00 and it closed at
$26.00 on expiration.

However, because you sold the 27.5 calls at $2.00, you would
only realize a $1.00 loss in the stock. The premium received
will offset the loss due to the fact that you identified and
adjusted for a likely move.

As you can see, the buy-write strategy can be altered to fit any
directional view you have on your selected stock.

Finally, if you intend to use the buy-write strategy
successfully, you generally need to sell the calls against your
stock on a consistent, recurring interval, over a period of
time.

This means that you will have to be prepared to “roll” your
calls out to the next month come expiration. Sometimes, all
you’ll need to do is to sell the next month out call.

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