THIS article is the first in a series from SMSF investor Christina Bong.

This SMSF investor series is about “thinking outside the box” as these strategies are a little different from the traditional investment strategies used by super funds to grow your money. These strategies are designed to be safer than traditional investment strategies like buying and holding stocks, where investors only make money when the stock market goes up.

The market does not move in only one direction. Sometimes the market can go sideways or down. These investment strategies will enable SMSFs to earn a decent return in all market conditions – up, down or sideways.

Most of my investment strategies involve the use of derivatives, such as exchange-traded options. At this point some of you may be thinking, “Aren’t derivatives dangerous?”

In 2002, Warren Buffet famously declared that derivatives can be “financial weapons of mass destruction” and this has become a well-known quote in the investor community. A lesser known fact is that his investment company, Berkshire Hathaway, engages in large-scale derivatives transactions which are used to facilitate certain investment strategies.

When questioned about this in an interview with CNBC in March 2010 Buffet said, “Cars are dangerous but every American wants to have one. Lots of things we use daily are dangerous, but we generally pay some attention to how they're used. We tell the cars how fast they can go.”

In other words, derivatives, like cars, can be dangerous. But if we learn how to drive them properly, they can be very useful vehicles for investors and that is what I would like to show you in this series of articles.

Most SMSFs like to invest in Australian blue-chip stocks. Stock investors normally have a watchlist of stocks they would like to own in their portfolio. The usual method for buying stocks is to wait for the stock to trade at a price that you deem as “good value”, at which point you would then place an order to buy the stock at that price. Do you know that if you use options, you can get paid to wait to buy the stock at the price you want? This strategy is called “selling cash-secured puts”.

Put options can be used to hedge your stock portfolio as they allow you to sell your stock at a predetermined price. In that instance, the investor would buy the put option as a form of insurance. If you are looking to buy the same stock, you can sell put options at the price you are prepared to buy the stock. Like insurance, there is a time premium for options so the option seller will be paid a premium by the option buyer.

Let’s walk through an example using CSL, which we will assume is a stock on your watchlist. On April 27, 2010, it was trading at $32.50 per share. You do your analysis and you think CSL is a good buy at $32 per share and you are not in a hurry to buy the shares. Below is a list of option prices on April 27 for CSL put options at the $32 strike for May, June and July 2010. You can collect premiums ranging from 70c to $1.12 depending on how long you are prepared to wait to buy the CSL shares.



If you are happy to wait one month, you can sell the May put options which will expire on May 27, 2010. You will be paid 70c for doing this. On expiration day, if CSL is trading at $32 or lower, you will be required to buy the CSL shares at $32 per share, which is the price you are prepared to pay. As you received a 70c premium for waiting to buy the shares, you are effectively paying only $31.30 for the shares, which is a 2.1% discount. You can get a higher discount if you are prepared to wait longer as you get paid higher premiums for longer-dated options.

What if CSL is trading above $32 when the options expire? You will not be able to buy any CSL shares at $32 but you get to keep the premium that you were paid when you sold the put options. If you sold one-month put options for 70c, this is equivalent to an annualised return of 26% on your cash (70c x 12 months / $32) on top of any interest that you may be receiving from keeping the cash in a high-interest savings account. To me, that is not a bad consolation price for “missing out” on buying CSL at $32.

Selling cash-secured puts is a favourite strategy of mine for getting into stock positions. As you can see from the above example, selling cash-secured puts does not involve more risk than buying stocks. In fact, it is less risky than buying stocks outright as the premium you receive for selling puts provides you with a margin of safety against a fall in the stock price.

If you like this strategy, you can find more information on how to do this on our website http://smsfinvestmentstrategy.com.au.

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