If you have little capital, just buy a stock you like and sell a one-year straddle and look at that premium you collect as a dividend. Then if the stock drops, you'll own an equal amount of additional shares reducing your average price. The premium you collect will also be your maximum gain as the stock will be called away at expiry if it trades above the strike. The return on capital should be more than 20% to be worth doing. If the stock is risky, you should be able to get at least 40% return on your capital. You won't have to look at it very often.
Most stocks that have this kind of potential return in one year playing it the way you suggest are probably going to be stocks the OP has never heard of. More than likely biotech small caps. When you say "pick a stock you like" that can be based on two things. Fundamentals, T/A, or both. (hopefully not a tip or a story) From a fundy standpoint, its very difficult to understand biotech unless you are a seasoned veteran of analyzing the sector. From a T/A standpoint.... one can NEVER use that on a biotech that could in theory pony up a 40% return. There's a reason for that 40% and its because there is a known black-swan event on the way. Good or bad. You might want to point out to the OP that to get that kind of return, he might end up doubling his share position buy being put the stock when it is trading down 60%+ with little chance of a bounce after bad news. Your post is correct Stymie....Just providing a note of caution to someone who's new at the options game. If it were that easy we'd all be loaded in a relatively short time. There's no risk free trades. Part of me wants to say "welcome back Marsman". Hmmmm.
If you are in the option space a better line of inquiry would be "Trying to find the right spread" .. let me explain.. the expected returns of options spreads are very dependent on the Iv regime. Try backtesting flies with vix at 12 vs 22 and you will see a huge difference in expected returns. Reverse holds for calendars. Once you zero in on a basket of names, determine what options spreads work under that iv environment THEN do your charts on the names to figure out how to exploit that certain spread. Ex. IF IV is low , buy calendars - some ATM, some on the call side, some on the put side, THEN do chart pattern analysis and group names likely to linger, go up or go down. .
Plenty of stocks out there - but your selling one year straddles so not get rich quick... Example:: GRPN trading at $4 with 4 Straddle out 283 days for 1.50. As I said above, you either own more shares at 2.50 or the stock is called away at equivalent price of 5.50 if stock is at 4/or higher on expiry. Your right in that if the Stock drops, there may not be liquidity in the options to sell another Long term Straddle. And as per my comments, you will own more shares at 2.50 if it goes down so you must be prepared to buy more shares and sell another Straddle which means in two years time, worse case scenario is Long 4x number of shares at average price of around 1.25/share. So managing your position size is critical as always. In this example, you should plan out two years and be ready to buy a 100 shares now and a minimum of 400 shares at an average price 1.25 or $500 dollars over two years and be ready to lose the 500 if the stock goes to zero. The risk of no option liquidity at $1/share is ok in that the stock is already an option. I just buy more stock when it drops another 50%. Time is the key - we wait for a bounce and target our 40% return for the year and move on. Still beat 99% of fund managers. But who has the discipline to wait than the investor who just wants to put the trade on and not look at it. So when buying stock, multiply the cost by 4 times and have that cash ready to be deployed over two years and be willing to lose that if the stock crashes to zero. The short Straddle will require little margin due to large credit and owning the stock. Perfect for a small trader. This trader has a few thousand dollars so GRPN would risk 25% of the account over two years. Start here and build confidence with cash coming in and little commissions going out. One year options mean tax consequences are in next years tax year so taxes delayed one year.
He could instead buy the stock and also buy a one-year OTM strangle? Unlimited gain on the up side and limited loss on the down side?
The strangle will have a higher probability of success but the total profits earned will be lower. Given the cost of transaction, I prefer to go with the lower probability straddle but higher profit earned as a result. But your right that the strangle is an equally good idea.