Buy/Write Combinations Offer Incredible Power for Investors

I'm now in my 44th year of investing in stocks and my 42nd year of trading options. After more than four decades of option trading, I can say unequivocally that I've made millions of dollars being an option seller.

Statistics show that over 80% of all option buyers end up losing money. Once you know that, you should ask yourself, "If most people buy options and lose, who do they lose their money to?"

Many people immediately say, "They lose it to the other 20%." That is not accurate, though. Options are a zero-sum game. If 80% of option buyers suffer losses, then the people who sold them those options won.

Professional option market makers, who are well aware of long-term results, are in the business of selling options to the public. Over time that is definitely the path to profits.

Buy/write combinations involve purchase of round lots (even multiples of 100-shares) of stock while shorting covered calls and naked puts on that underlying security, often for the same expiration date at identical strike prices.

Why does this technique work so well?

Selling options always offers a high probably of success. Booking two sets of option sales on the same stock, using the same expiration day, yet for opposite opinions, increases potential returns, while also providing generous "margins of safety" vs. simple purchase of the underlying shares sans option sales.

I'm going to show you two already completed buy/writes to illustrate my point. The first example, on Tenneco (TEN) was a trade that generated a less-than-hoped for share price action through expiration day yet still was profitable at my initially stated "worst-case scenario."

The second example, on Berry Global (BERY) worked out perfectly. The shares closed above the strike price selected on expiration day. That delivered the "best-case scenario" detailed in my original write up.

Here was my recommended 1,000-share, 10-call and 10-put combination using aggressive in-the-money $15 strike prices with the shares then at $11.30.

The huge option premiums received dropped my initial out-of-pocket net cash outlay to just $3,750.

If TEN had held above $15 on Jan. 21, 2022 the best-case scenario detailed next would have been in effect.

As it turned out that did not happen. TEN closed on expiration day at $10.50, 7.08% below my trade inception price.

Was that a bad trade? Read on before saying "yes."

Because it failed to hold $15 on expiration day, combination sellers would have kept their original 1,000 TEN shares and been "put" an additional 1,000 shares as well.

A further $15,000 in cash would have been required to fulfill that option exercise. Due to the math of the buy/write, though, as described above, the average net cost of those 2000 shares would be just $9.375 per share.

The extra 1,000 shares would have hit your account over the weekend. During the very next trading day your 2,000 share new position would have been worth $21,620 at the closing quote of $10.81.

Simply sell then would have generated a net gain of $2,870 based on the start-to-finish net cash outlay of $18,750.

Think about that. The stock you bought the previous March was lower than it was at trade inception, yet the buy/write combination seller would have shown a paper profit of over 15.3% on a now double-sized position. How cool is that?

But wait, there's more. Investors who sat tight with Tenneco rather than bailing out quickly got great news last week. Apollo Management (APO)  announced a buyout of TEN at $20 per share.

Owners of 2,000 TEN shares who still owned it could have cashed out for $39,060 on Feb. 23, 2022 netting a cool $20,310 start-to-finish gain.

That is quite incredible considering the stock did not perform as expected by the scheduled option expiration date. How's that for what was originally a "worst-case scenario"?

Berry Global Group (BERY) , was recommended on Jan. 30, 2021 as good candidate for a Jan. 21, 2022 expiration date, $60 buy/write combination as shown below. At that time the stock was available for under $50 yet appeared very promising for year-ahead performance.

The cash flow details below outlined the actual trades on a 100-share, one call and one put combo using an aggressive deep-in-the-money strike price which was more than 21.4% above the trade inception price.

Things worked out brilliantly. BERY closed on expiration day at $69.21, more than $9 above where it needed to be to deliver the best-case scenario result.

Rising from $49.40 to $69.21 would have been a 40.1% gain for those who simply purchased shares without selling any options. Nobody who did that would have anything to complain about.

Sellers of the buy/write combos, though, netted a cool 81% over that same holding period. That was more than twice the gains for simple buy and hold investors.

It didn't end up being necessary on BERY, but buy/write sellers also got downside protection of 5.7% from the trade inception price if BERY had disappointed rather than risen sharply.

Buy/write combinations offer the best of both worlds. You get well-defined, often huge, upside potential while also receiving a degree of protection against poor market action. In the majority of cases you will also outperform "plain vanilla" simple ownership of the same underlying shares. 

At the time of publication, Price was no longer long TEN following the buyout announcement; but was still long BERY shares and short BERY options. No positions in any other stocks or ETFs mentioned.