The Right Way to Go Long on ProShares Ultra S&P500

I want to enter the market and the ProShares Ultra S&P500 (ETF) (NYSE:SSO) is my poison.  ProShares Ultra S&P500 is an exchange-traded fund that seeks performance that corresponds to twice the daily performance of the S&P 500 index (before fees and expenses).  However, because the market is so extended, I desire to invest with a margin of safety to protect against a downturn.

I will implement my margin of safety by selling stock options.  Selling options on stock you already own is not nearly as risky as most people think.  In fact, selling options on stock you own, termed a “covered call,” is one of the safest ways to invest.  In fact, it is so safe that the government allows you to sell covered calls in an Individual Retirement Account (IRA). 

Here’s My Plan
Based on end of day prices checked, buying 100 shares of ProShares Ultra S&P500 (ETF) (NYSE:SSO) for $36.90/share and then selling the $36 Nov 2009 Call (SOJKJ) contract for $2.25 will net me 3.9% profit if SSO closes above $36.00/share at the expiration date in 37 days (excludes commissions for calculations).  This is a pretty great return for just over one month of investing and my average monthly gain would be 3.27%.  Additionally, I have a big downside protection to $34.65, or about a 6.1% drop in stock price.

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That return may sound small at 3.9%, but when it is annualized, the Compound Annual Growth Rate (CAGR) on the assigned option position is a whopping 45.9%, which is much better than the average overall long-term market return of 10%.

My Plan if SSO drops 6.1% and Closes Below $36.00:
If SSO closes below $36.00 at any time during the trade, I will have lost money on the stock.  However, I can roll down the call position by purchasing back the $36.00 Nov 2009 Call contract at a profit and then selling another call at a lower strike (say the $34.00 strike) and/or further date out to make up for any losses caused by the drop in stock price and cost of having to buy the $36.00 Nov 2009 Call back.  If the stock recovers, I will be able to simply sell out of the position for a profit or roughly even money if I don't want it tied up in the positions.

If ProShares Ultra S&P500 (ETF) (NYSE:SSO) continues to drop further than $34, I will own the stock for less than $34/share when I was originally interested in buying at $36.90/share.  How cool would that be?

Disclosure: No positions in SSO at the time of this writing, plan to purchase at market open tomorrow, October 16.