The Time May Be Good For Stock Replacement

The Daily Options Report blog recently discussed the current low levels of implied volatility as measured by the VIX. When implied volatility is low, option prices are inexpensive, relatively speaking. For long equity investors, this can create an opportunity to replace current long positions with call options, especially those positions that have recently run up. The replacement strategy allows the investor to remain exposed to the upside potential of the position, while also limiting downside risk.

Of course, the strategy is not without its potential costs. First, any gains in the sold long position will be taxed. The options also have a finite life, so the position cannot remain open as long as you may like with the equity position. There is also always the potential that the stock will remain range bound, thereby draining away the time value of your option - although your stock may have not gained much anyway over the same time frame. Once again, not a perfect strategy, but given the current low implied volatility, the strategy is worth a look. Buying puts can also give you a similar payoff, although your overall return may be different since the protective put ties up more capital as you keep your long position open.