Discover the Versatility Options Provide

Physician's Money Digest, May 15 2003, Volume 10, Issue 9

Stock options are versatile investment toolsand suitable for use by any physician-investorwho wants to reduce the risk ofstock ownership in their portfolio. The followingare ways in which stock options can be used:

  • Buy stock at a lower price;
  • Sell stock at a higher price;
  • Profit whether your stocks increasein price, remain constant, or slightly declinein price;
  • Bet that a stock will undergo alarge change in price;
  • Protect investments against loss;
  • Provide income; and
  • Lock in an investment profit.

Sometimes it is difficult for physician-investors to learn about optionsbecause their investment advisors haveignored the tremendous benefits optionscan provide. But, help is available. Ifyour broker is unwilling to help, it is easyto find a new broker. Ask your branchmanager to assign your account to thetop options broker in their branch.

ONCE BITTEN, TWICE SHY

Many physician-investors lost substantialsums in the current bear market. It may betempting to take chances to recover those lostfunds, but a prudent plan is to adopt a strategythat results in fewer (and smaller) losses and morefrequent profits. In today's market, these are idealattributes for your holdings. Patience and a goodstrategy can recover those losses. And calls are agood tool in this strategy. The following is a reviewof the most basic definitions involving options:

• Call option. This is a contract giving itsowner the right to buy 100 shares of a specifiedstock (underlying) at a specified price (strike price)for a specified period of time (until expiration).The choice is in the hands of the optionowner. They are not obligated to buythe stock, but have the right to do so.

• Put option. This is the same as acall option, but the put owner has theright to sell the underlying stock.

BUYING OPTIONS

If you buy an option, you are bettingthe price of a specified stock moves inyour favor (for calls, the direction is up;for puts, the direction is down).The riskof such an investment is limited to theamount paid for the option.

Nevertheless, this is a risky strategybecause the option owner frequentlyloses most or all of their investment. Tooffset those losses, the option buyermust occasionally turn a small investmentinto a sizable profit. That is thereason many people buy options—thepossibility of a bonanza. I recommend that physician-investors opt instead for covered call writing.

COVERED CALL WRITING

Covered call writing has 2 main goals: to earn agood profit and to obtain protection against loss. Toimplement the strategy, 2 steps need to be taken:

1. Buy (or use stock you already own) 100shares of stock; and

2. Sell a call option, granting someone elsethe right to buy your stock, and receive a cashpayment. In a nutshell, here is an example ofhow it works. You decide, today, to buy 100shares of stock XYZ at $40 per share, costing$4000.You then sell 1 "XYZ Nov 40 call at 4".You, therefore, receive $400 for a call option thatexpires in 6 months.

Your investment is $3600.When expiration dayarrives in November (always the third Friday ofthe month), there are 2 possible outcomes:

1. If XYZ is priced higher than 40, the optionowner exercises their rights and buys your stock,paying $40 per share. Your profit is $400, or areturn of 11.1% on your 6-month investment.

2. If XYZ is less than 40, the option owner willnot buy your stock. The option expires worthless,and you are no longer under any obligation to sellthe stock. Instead of owning XYZ at $40 per share,you own it at the reduced price of $36.

Each outcome provides a good result. Thisstrategy is not perfect, but overall, it reduces riskand makes profit more likely. Thus, this strategy isworthy of consideration by physician-investors.

Options are not for everyone, and there is noguaranteed profit when using them. Both optionsand stocks are investments with the potential forreward, but losses can occur, no matter how conservativeyour strategy. By being aware of risk atall times, you can make better investment decisions.The profit potential is substantial whenoptions are part of your portfolio.

Mark D. Wolfinger,author of The ShortBook on Options: A ConservativeStrategy for theBuy and Hold Investor, isan educator of publicinvestors. He was a professionaloptions traderat the Chicago BoardOptions Exchange forover 20 years. He welcomesquestions orcomments at mark@mdwoptions.com. Formore information visit www.mdwoptions.com.