# The protected Income Strategy



## stuart.mcclure (26 September 2008)

Gday all,

Over the past 6 months i have been working on a low risk strategy that could easily survive the current bearish and sideways market conditions. The strategy is used in replacement of covered call or buy and hold portfolios, it is not a trading strategy rather an investment strategy.


Ok so here goes, below i have detailed exactly how the strategy works and why i have chosen to do things this way. I have had great success with this strategy using stocks in the ASX top 20.

Step 1 - Purchase protection

Protection is expencive at the best of times, fortunately buying long dated reduces the cost on a month to month basis. To combat this, we place the following trades.

1. Buy Long dated (12 month out) puts around 10% below the current share price.
2. Sell short dated puts (1-2 months out) at the money.

The reason we do the above is it makes the protection very very cheap, if volatility is high enough, this transaction can actually be performed for free. 

In laymens terms, the above trade is the same as one saying, I will not buy the stock today at xyz price, i will buy it next month at the same price with a free protective put 10% below the current share price.

There are 3 outcomes of this initial trade.

1. The stock rallies, the short dated puts expire worthless and we can either sell new puts for a large profit or liquidate the entire trade for a profit. The profit results from the short dated puts losing more value as the delta is higher than the long dated puts.

2. The stock goes sideways and the sold puts are either re-sold if they are below the current share price or are either rolled or exercised if they are in the money.

3. The stock plumets, we are exercised on our sold short dated puts, we may try and roll these down if there is a profit in doing so, or alternatively buy the shares and roll down the protection to lock in the fall and effectively lower our purchase price.

Step 2. Sell calls.

Once we own the shares, which may or may not ever happen depending on how the shares behave, we are free to sell calls over the stock every month until either the protection expires and we are forced to sell the shares or the stock rallies and we cannot roll up our calls anymore and we must exercise our rights and sell our shares at a higher price.

NB: We are able to sell calls every month as even if the shares fall dramatically in value, we can simply roll down our protection to a lower strike, effectively lowering our purchase price and re-sell calls. Usually this transaction results in a breakeven however it varies depending on volatility and the extent to which the shares have fallen.


My Analysis.

Pros -Small defined risk.
       -High probablity of success
       -High % returns compared to risk (avg 2% return on exposure)

Cons - If the market falls consistantly for 12 months, there will be little  chance of achieving a  profit as you will be constantly rolling down protection and selling calls for a break even and no profit. 

Let me know if i have not explained this clearly as i have a few actual trades i could upload to help show exactly what i do.


Regards,

Stuart McClure


----------



## wayneL (26 September 2008)

AKA bull put diagonal and synthetic equivalent.

Nuttin' wrong with this at all so long as the risks are known. Management is the key as stated.


----------



## wayneL (26 September 2008)

The same thing can be achieved with calls.

Buy deferred calls 10% below price action.
Sell ATM near month calls.

That way you never have to cough up the capital for the shares.

Again management is key... avoid assignment on the shorts calls etc.

Just another way to approach it.


----------



## stuart.mcclure (26 September 2008)

QUOTE:  

AKA bull put diagonal and synthetic equivalent.

Nuttin' wrong with this at all so long as the risks are known. Management is the key as stated.

Repsonse: Correct i can see exactly what you mean, however i figured most people would not understand the above so i explained it in my longer version.

In regards to your second comment, i cannot see how this would be possible with defferred calls, how would you gain the ability to roll down your purchase price if the stock dropped. Can you explain this in more detail?

Regards,

Stuart McClure


----------



## wayneL (26 September 2008)

You simply roll the long dated call down, exactly the same way you do with the long dated put.

Puts or calls doesn't matter much, it depends how you want to manage it. If you want to end up with stock, use puts. If not use calls.

Give me an example series of trades and I'll show how it could have been done with calls.

Cheers


----------



## mazzatelli1000 (19 October 2008)

stuart.mcclure said:


> Cons - If the market falls consistantly for 12 months, there will be little  chance of achieving a  profit as you will be constantly rolling down protection and selling calls for a break even and no profit.




I wonder how this is doing atm?


----------

