WDB Options Model
Where the market pays you to take a position.
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If you have unused margin in your portfolio (say from owning a bond or ETF) you can use that buying power to create an income stream and get paid by the market to do it. How? Through writing Put options on good quality stocks. But how do we 'get paid', you ask? If a Put option's premium is greater than the margin requirement to hold the position (if exercised) it means the market will literally pay us to take that position.

For example, company ABC is currently trading at $7.50/share and the three month $10 Put options are $3.50. The typical margin requirement (if exercised on the $10 Put) will be [($10 x 30%)x 100] = $300 (carrying cost). The premium collected for writing that Put will be ($3.50x100) = $350 (income). Our net margin liability from the day we do the trade is +$50 (where the market 'pays' us 16.7% to do the trade) regardless of where the stock moves to in the future. Only at some point down the road (when we ultimately close out the position) would we realize an actual gain or loss from the trade. Commissions and brokerage margin rates can/will reduce returns but the above example is for illustrative purposes only.

So why does this work? The primary reason this strategy is even considerable is due to very low interest rates. The associated carrying costs of borrowing on margin for investment purposes are very low. One might argue we are doing exactly what the Fed wants the public to do - borrow at low cost and invest. At the same time, we live in a very volatile and uncertain world which often leads to over-exaggeration. Because option prices are not fixed, they can and do move on short term investor sentiment (fear/greed). That sentiment (or perceived risks) can greatly effect volatility which in turn greatly effects price. Our core beliefe is By being able to ride out short term volatility, we can take advantage of market irrationality. In reality, we are being paid to realize a capital gain now (inflated option premium collected) in exchange for booking a potential paper gain/loss (Put option exercise price - actual sale price) at some point in the future. The key to this model is that we don't mind getting exercised on the written Put because we only consider stocks that are deeply discounted and trading at very good fundamental valuations (our screened universe). These are stocks we would want to own. Considering our strict fundamental criteria (like only buying issues trading below book value) we always anticipate a capital gain on the stock transaction, should we get exercised. Interestingly, the carrying cost of ownership by the model's definition can and ought to be negative (30% of the strike price - option premium collected) and can be further reduced over time through a prudent covered Call strategy.

So what's the 'catch'? If this was so easy and obvious why isn't everyone doing it? There are both psychological and capital barriers of entry that prevent most from participating. Our society has placed such a negative connotation on 'derivatives' many will simply not participate - regardless of how compelling the trade may be (wiki link on derivatives risks). On the heels of these fears, regulators permit only those brokerage house retail clients deemed 'sophisticated investors' from writing options. And as a further measure to keep the public out of this arena regulators require retail customers to post a maintanence margin requirement while holding any open option position. This maintenance margin requirement is never charged and disappears once the option either expires or is exercised but does represent yet another barrier. As a result of these various filters, less then 5% of all potential investors even get to the point of opening an options account. For those few that can appreciate that these 'barriers' are not really barriers but simply requirements to be meet a whole new world of investing opportunites opens up. You can learn more about WDB's margin requirement calculations and their reporting here.

So what do we do here at The WDB Options Model? The model's sole purpose is to highlight stock Put options where their current market price (or premium collected if you write the option) is very high relative to the carrying cost of owning the stock on margin should you be exercised (and have to buy the stock at the exercise price). Additionally, we track what the cost of carrying that option to expiry will be. We run several algorithms that not only filter the broader stock market for exceptional 'value' ideas but also screen for any Put options on those stocks where one can literally get paid to take a position. We provide this information to our subscribers in an articulate, usable and timely fashion. You can learn more about the model and our history here.

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