Stocks Lead The Way, Followed by Data: Covered Strangle

Don’t let the headlines dictate your decision-making. Last week, the S&P Case-Shiller home price index report for February came out, indicating that U.S. home prices stumbled again, hitting new lows among its 10 and 20 city measures.

However, this number does not account for the positive momentum in the housing market. Whether you take the Peter Lynch approach and speak with realtors or listen to the CEO’s of Toll Brothers and D.R. Horton, they are painting a more encouraging picture and their stocks have responded.

When we see the stocks of a particular sector rally after a long-term decline, expect for positive data to lag the securities of that group. What often happens is that the stocks of the group move up 20-40% followed by a period of consolidation, which gives empirical data and industry reports time to “catch up” with their statistics. From this point, if the rally is for real, you may find a secular growth pattern on your hands which allows for several options strategies.

One particular strategy that works well in this scenario is a COVERED STRANGLE.


This strategy is applied when you are bullish on a stock’s long term prospects and you’d be willing to pick up additional shares, if the security were to pull back in price.

With a COVERED STRANGLE, you buy the security, write an out-of-the-money call, and sell puts. If the stock stays where it was when you put on the trade, you will collect the call premium and the put premium, while retaining the stock. If the stock moves up, you will collect the call premium, the put premium, and the appreciation between the stock’s price at the time the trade was entered, plus its’ appreciation up to the call strike price. If the stock falls below the level where you wrote the puts, you will collect the call premium and the put premium, but you will be long additional shares at the put strike price, relative to the amount of puts you sold. This could be viewed as positive considering you added additional shares at a lower price.


Let’s use the Gap (Ticker:GPS) as an example:

Over the past several years, the Gap has lost its way and the company just hasn’t been able to revert back to its glory days in the 80’s and 90’s, when everyone was wearing their affordable, stylish, quality wares.

Recently, the tide has turned for the Gap. Beginning last year, The Gap acknowledged that they would have to make serious changes to management, designs and marketing to keep up with new competitors such as LuluLemon and older brands that have recently leap-frogged them, IE Macy’s.

Through improved styles, marketing and advertising, the Gap appears to be back on track. The stock is up over 40% this year and technically, it looks like it will go higher. With Banana Republic, Old Navy and the Gap, the company has three strong brands and the future (again) looks promising.

Therefore, a covered strangle might be a good options strategy.


Buy 100 shares of GPS @ $28.53
Sell 1 GPS May $28 call for $1.24
Sell 1 GPS May $26 put for 19c
For a $1.43 credit.
Cost basis: $27.10

This is just another way where our team at The OptionWiz uses our experience to provide low risk, high reward options strategies.

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