As share investors, our ultimate aim is to buy shares low and sell them when they rally. Sounds easy, right?
If it were that simple the sharemarket would never correct and it would be in a continual upwards spiral. That lesson was learnt all too well in the Global Financial Crisis (GFC) in 2008-09 and again in the COVID-19 sharemarket correction in March 2020. If you held shares then, you had plenty of sleepless nights.
As individual investors we can learn from what many professionals (active fund managers) do to try to outperform the index. Here are the three main ways:
The key premise behind their strategy is to own only the stocks they are happy to hold (using fundamental analysis to determine value or growth shares).
This ASX Investor Update article summarises the difference between value and growth investing.
Knowing when to buy and when to sell is often achieved through technical analysis. Fund managers and brokers often rate stocks as a buy/hold/sell with price targets and will hold shares up to a certain price and buy or accumulate shares if they dip to a lower price.
By using Exchange Traded Options (ETOs), fund managers can potentially lock in lower purchase prices and higher selling prices whilst generating an income stream.
Options can also be used to minimise losses. Here, investors effectively “insure” their portfolio of shares against large market corrections. This strategy can ensure there are limited drawdowns on portfolios during market crashes. (There is more on this strategy later in this article).
Three strategies to learn over Christmas will help you implement the same strategies as many active portfolio managers to generate income, systematically turnover your portfolio and insure your portfolio against a major downturn.
ASX recorded a series of videos to help you understand the fundamentals of implementing the following strategies (see below)
A covered call written say 5-10% above where the market is trading locks in a sale price if the market rallies but importantly generates an income stream, as the buyer of the option pays you a premium that is yours to keep.
Another way to look at covered-call options is that they are similar to putting your house on AirBnB, with an important caveat: When you lease out your house, the tenant can’t take it off you but, with a written-call option, the buyer can take the stock at a particular price.
The cash-covered put is often implemented after a covered call when the investor has sold their stock. The strategy earns income similar to the covered call but uses cash in the bank rather than stock held to purchase shares 5-10% below where the market is trading.
Buying puts acts like insurance for shares and helps you avoid the financial stress of a stock market crash. By using some of the income received throughout the year from covered calls and cash-covered puts, you can protect your portfolio for minimal cost.
Understanding these strategies will help you to build your investment knowledge and set yourself up for buying low and selling high via options.
More information about the features, benefits and risks of options is available as the ASX Options Knowledge Hub.