Money for Nothing

TomAndersonEven if Washington isn’t working this week there is a conservative trade that can set you on the path to being a millionaire.

As our elected officials drag their feet this week and postpone the inevitable debt ceiling increase, markets will be forced to do nothing.  This situation has become all too common but there is something you as an investor can do about it.  This is the perfect time to execute a covered call strategy.

When you sell a call, you are offering to give somebody stock in the future.  The person who is buying this call, is betting that the stock will go up.  Since you think the stock will stay flat or bounce around directionless, you are willing to take the other side of the trade.  A covered call is simply selling a call on stock that you already have in your portfolio. If someone were to exercise the call and ask you for the stock, you would have the problem covered.
You don’t offer this service for free.  You own the stock because you think the share price will go up in the future, just not today.  So, in order to get you to sell a call, the buyer of the call has to offer you something in return, a price that is higher than the market.  If you think the stock price is going nowhere between now and expiration, this is a good deal.

Since you already own the stock, delivery is the easy part and by selling the call, you are locking in a sale price that is higher than the current market price.  If the stock price remains stable or falls as the exercise date approaches, you just sit back and count your money as the put loses value.  If the stock price appreciates, the stock will be called away from you but you’ve locked in a better price than you would have received if you sold the stock that day.  You only lose if the stock price falls dramatically so only use this strategy with companies you would like to own over the long term.

Why would a covered call strategy be promoted by the writer of a growth newsletter?  Simple, there’s a discrepancy between what will happen in the short and long terms.  We’re in a grinding market as Washington sorts through its issues, but its the historic growth of the stocks that options traders use when calculating the price of calls.

Technology growth stocks like Yelp or Rubicon have higher priced options because the possibility for dramatic price appreciation exists.  These are good candidates if you are careful to avoid selling calls near analyst days or investment conferences which may act as positive catalysts.

Lets take a look at an example: Yelp is currently selling for $67.50 and $68 calls expiring this Friday are selling for $2.  This amounts to a nearly 3% return!  If you could find a way to return 3% on your portfolio every month let alone every week, you could turn $25,000 into $1,000,000 in slightly over 10 years.

Nobody really expects the US Government to default on its debt but this lull in the market could offer an opportunity to generate low risk profits from a portfolio of high growth stocks.  As long as you keep potential catalysts in mind and are comfortable with the possibility that the stock could be called from you, a diligent investor can use a covered call strategy to generate meaningful income when the market lacks direction. 

Tracking the Jackpot,

Tom Anderson.


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