How to Use the Fig Leaf Options Trading Strategy

The basics of the fig leaf options strategy with Bernie Schaeffer

Apr 12, 2022 at 10:14 AM
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    There are many options trading strategies that you can use to supplement your income. The Fig Leaf strategy is a method of using options to protect against losses. The unusual name name refers to the story of Adam and Eve, in which the two were able to hide from God by covering themselves with leaves from a fig tree.

    While a trader can use the strategy for any investment, it's commonly used to protect against losses on stocks. You should use the fig leaf strategy because it helps reduce risk while still generating income from your investment portfolio. The covered calls provide income while protecting against downside risk with the short put spread. If the market moves higher or stays flat, you will earn money on both positions for a net profit.

    What is the Fig Leaf Options Strategy?

    Leveraged covered calls, or "fig leaf" options strategies, can generate income from thinly traded stocks.

    This strategy is similar to a covered call, but you own a long-term call option instead of holding the stock. This allows you to write a shorter-term call over the long-term option — which will sell for less than the underlying asset — and pocket the difference as income on your trade.

    When looking for a stock to write a fig leaf option against, you need to find an issue with weekly options available but a high chance of seeing price movement during the week. You're looking for a relatively volatile stock with plenty of liquidity in its weekly options.

    The key to running this strategy is finding the right long-term option to write your short-term call against. The goal is to purchase a LEAPS call to see price changes similar to the stock. The goal is to buy a LEAPS call to see price changes identical to the store. So look for a call with a delta of .80 or more.

    This strategy is an alternative to purchasing the underlying stock. But you can also use it to reduce your cost basis on a stock that you already own.

    For example, say you're interested in adding shares of XYZ Inc., currently trading at $45 per share, to your portfolio. You can buy 100 shares of the stock for $4,500 (plus commissions). Or you could spend about the same amount — $4,400 — buying a December 50 call. That's still less than 10% of XYZ's market cap and represents just over 4% of the company's current share price.

    What Are the Advantages?

    The downside is that there's a potential opportunity cost — if the stock rises substantially above your covered call strike, you give up gains beyond that level in exchange for having received the premium from selling that call.

    If you want to accumulate shares of a company but are hesitant to put too much money on the line because you're unsure of how the stock will perform, the fig leaf strategy can be a way to ease into a position over time. The strategy also can serve as an alternative for dividend investors whose portfolios have been hurt by low returns on bonds and cash.

    The fig leaf strategy works best in a volatile market, where stocks regularly trade in wide ranges. That's because this gives you more opportunities to sell covered calls, but it also gives you more chances to buy back those calls at lower prices than what you sold them for, potentially offsetting some of your losses on the stock.

    If you sell a covered call when a stock is trading near its 52-week high, your downside risk is limited to the amount you paid for your shares. And if the stock falls sharply and stays below your covered call strike price, you will be glad that you received premium income from selling those calls.

    The fig leaf strategy is particularly effective when the market conditions are uncertain or volatile. When volatility is high, option premiums increase. If you sell a covered call when implied volatility (IV) is high, you receive a higher premium income than if IV is low.

    When Should You Apply the Fig Leaf Options Strategy?

    In a regular covered call, you sell calls against your stock to generate extra income. If the stock price rises enough, you may be assigned and forced to sell it at the strike price on or before expiration. But if the stock doesn't rise above the strike price, you keep the stock and all premiums received from selling the calls.

    If you own an underperforming stock and don't want to sell it, you can use this strategy to collect some cash while waiting for it to bounce back.

    The downside is that there's a potential opportunity cost — if the stock rises substantially above your covered call strike, you give up gains beyond that level in exchange for having received the premium from selling that call.

    To avoid this opportunity cost, you can "roll" the position by buying back your original short call while simultaneously selling another call at a higher strike. This allows you to retain exposure to any substantial move higher in the stock and collect additional income from selling another out-of-the-money call with a later expiration date.

    The fig leaf strategy is a popular combination of options that traders can use to protect your portfolio from losses in bear markets and allow you to participate in profits during bull swings. The strategy uses a put and call to create a corridor for the underlying asset to fluctuate.

    The strategy is popular because it is flexible and can be customized based on your specific situation. For example, if you have a prominent position in XYZ stock and want to protect the downside while still keeping some upside exposure, you can create the fig leaf using XYZ call and put options. Or, if you have an ETF portfolio that you want to protect, use the ETF options instead.


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