I was asked Wednesday about why certain stocks were in an options overwriting fund that, after starting out the year strong, has recently been underperforming. Although I am not one of its fund managers, I do have insight into the investment approach involved. At their core, most option overwriting strategies involve a long position in the underlying stocks and a short position in options to generate some “yield” in the form of harvesting option premiums. The manager may employ a conventional “buy-write” strategy, buying the underlying shares and selling or “writing” an upside call option, selling downside puts, or, more creatively, if the circumstances warrant it, selling vertical spreads to generate the premium, among other options. Options have non-linear payoffs, they expire, and may involve unfamiliar language, such as “the Greeks,” which measure their sensitivity to changes not only in the price of the underlying stock but also in rates, dividends and volatility assumptions. This perceived complexity — and occasionally a somewhat misguided sense that there’s something magical about them — often leads investors to look at options prices first in their screening process, rather than the underlying stock. Horse before the saddle While one might get away with that in volatility arbitrage, with an options overlay strategy, this is a mistake. Using options prices to choose a stock is like buying a horse by examining the saddle. There are several valid approaches to picking stocks, be it bottom-up fundamental analysis, top-down macro, technical, or momentum-driven, etc. To that end, I screened the Russell 1000 Wednesday to identify stocks that met a couple of criteria. Positive momentum (higher over the past month), price-to-earnings growth (PEG) ratio less than 3 and price higher than the 50- and 200-day moving average as a starting point. One of the 72 stocks in the Russell 1000 that met these criteria post-close on Wednesday is SoFi Technologies . SoFi continues to evolve from a niche online lender into a diversified, regulated financial platform with a balance-sheet strategy that increasingly resembles a high-growth, digital-native bank. The bullish thesis rests on three pillars: structural cost advantages, a multi-product engagement model and accelerating operating leverage as the company scales into its bank-charter economics. Not cheap All that said, at more than 50x forward earnings, or roughly twice the market multiple, although with a respectable growth rate, SoFi is not particularly cheap, particularly when compared to traditional banks, which are, on average, trading at roughly half the market multiple. Here, we have a stock that is up more than 100% year-to-date, which ticks several of our boxes when screening for long trades, but valuation might be getting somewhat lofty. It is at this stage, where we have several factors working in favor of a stock and one or two working against it, that we might evaluate whether using an options overlay is a better way to play it. Because the stock has relatively high volatility, a decent amount of options premium is available in it. Consider that one could sell the 36 strike weekly calls expiring Dec. 26 against a long position for roughly $1.60, which is approximately 5% of the current stock price. Those calls are more than 10% out of the money to the upside. If SoFi moves up 10% by Christmas, this trade would yield roughly 15%, and if it falls by 10% by that time, this trade would result in a 5% loss (the 10% loss in the stock offset by the roughly 5% in premium collected on the short call). The result: Meaningful upside participation, a meaningful standstill yield, and a fairly helpful buffer in the event the stock’s momentum turns against us. DISCLOSURES: None. All opinions expressed by the CNBC Pro contributors are solely their opinions and do not reflect the opinions of CNBC, NBC UNIVERSAL, their parent company or affiliates, and may have been previously disseminated by them on television, radio, internet or another medium. THE ABOVE CONTENT IS SUBJECT TO OUR TERMS AND CONDITIONS AND PRIVACY POLICY . THIS CONTENT IS PROVIDED FOR INFORMATIONAL PURPOSES ONLY AND DOES NOT CONSITUTE FINANCIAL, INVESTMENT, TAX OR LEGAL ADVICE OR A RECOMMENDATION TO BUY ANY SECURITY OR OTHER FINANCIAL ASSET. THE CONTENT IS GENERAL IN NATURE AND DOES NOT REFLECT ANY INDIVIDUAL’S UNIQUE PERSONAL CIRCUMSTANCES. THE ABOVE CONTENT MIGHT NOT BE SUITABLE FOR YOUR PARTICULAR CIRCUMSTANCES. BEFORE MAKING ANY FINANCIAL DECISIONS, YOU SHOULD STRONGLY CONSIDER SEEKING ADVICE FROM YOUR OWN FINANCIAL OR INVESTMENT ADVISOR. Click here for the full disclaimer.
