Get Rich - Stay Rich - Investing for Monthly Income
Sponsor Products

Archive for April, 2011

Selling Puts for Monthly Income

When you buy an option, you are hoping for a move in the stock based on a chart or event or your brother-in-law’s advice (bad move there).  Hopefully, you watch the option move up and then — when greed, fear or satisfaction set in — you sell and make a profit.  Or you watch it go down and either have an automatic stop loss in to sell it when it hits a certain level or, like most traders, you keep your fingers crossed and hope for the best … until the pain of losing on paper is greater than the fear of losing real money and you sell at a loss.

In a recent survey, results showed three out of four options traders still trade this way.  Accordingly, the same survey showed that three out of four options expired without being exercised or with any value.   And yet, the traders who took the “sell” side of the trade put money in their pocket on Day One of their trades, every single time.

Selling is a low-risk option strategy and a low-risk way to generate high monthly income and a great entry point to purchase stock at a lower price.

Here are several things to consider:

When you sell an option, you are collecting the cash up-front.  You are already ahead.
 
When you sell an option, you are transferring risk to the buyer.  Yes, when you sell options, you assume some risk but not to your capital.
 
This cash you collect upfront gives you the ability to manage the position – you have cash in hand to “close” or buy back the put or call, at a profit or loss, without using any or a good deal more capital.  This enables you to conserve capital, the basis for regular monthly income.
 
And accepting cash enables you to create targets for your positions.   The sum of these targets, when set properly, gives you a target income for the month … and that is what this is all about.

And selling puts let’s you decide the entry price when buying stock.  For example, you can sell a put to purchase a stock that you will sell covered calls against when it is put to you.  Then, you sell monthly calls until the stock is called away.  Then, back to selling monthly puts to re-enter the stock.  Rinse and repeat!  Over and over in the stocks that you want to generate monthly income.

Selling puts is actually a bullish tool.  The advantage to selling puts over buying calls is evident in the math:  The odds of winning are significantly increased.  Many professional traders use the short put strategy to buy stocks at prices they want.  Nobody wants to pay the highest prices to own shares, but when the stocks pull back – and stocks always pull back – the market helps you to get in at a better price.

But what if you don’t want to buy the stock?  Don’t sell puts on stocks you wouldn’t want in your portfolio.  You will get taken out of the trade if the buyer wants to exercise their rights (to “put” stock to you at the option’s strike price), and those are the kind of stocks you probably want to own!

This is always the risk with short puts, but it’s hard to call it a “downside” when you end up owning a good stock at a great price.  Besides, even if you are assigned to take possession of the shares, you can always sell them on the open market.  In fact, you can often get out for a better price and, thus, a profit … and repeat the strategy, if you choose.   Better yet, if the stock goes up and your put gets assigned, just sell a covered call against the shares and you’ve just established a new position in your portfolio — and another way to profit!

Option Basics – What is an Option?

An “option” is a standardized contract originated by the Options Clearing Corporation (OCC) that is exchange-listed.  A stock option is a legal right, but not obligation, to buy or sell shares of a specific stock for a fixed time and a fixed price.  The fixed price gives the option holder the right to buy or sell at a fixed price known as a strike price or exercise price.  The fixed time indicates that a option has a limited life for only a specific period of time then expires.
 
There are two types of options:
 

  • Calls – the right, but not the obligation to buy the underlying stock
  • Puts – the right but not the obligation to sell the underlying stock

How to buy & sell Options

  Click to enlarge.

The underlying stock are the shares of stock that are subject to a stock option.  The underlying stock can also be an exchange-traded fund, stock index and other tradeable securities that have options.

Each listed call or put option covers 100 shares of the underlying stock.  Stock options expire on the Saturday following the 3rd Friday of each month.  This 3rd Friday is the last day the options can be traded as the market is closed on Saturday.  If the 3rd Friday is a holiday, then the last trading day will be the Thursday before.  Recently, weekly options have been open on a limited number of stocks and ETFs.  These weekly options are opened on each Thursday and expire on Friday of the following week.  This gives the weekly option a time period of 8 days from opening to close.

There are many different calls and puts trading on each security that is optionable.  Each call and put strike price of each expiration month is a separate option series.  To be part of the same series, the options must be of the same type and have the same expiration, strike price and underlying security.   

The Dirty Little Secret of Option Trading

secret-to-option-selling

Options are a like a ticking time bomb in your hand.  If your preferred method of trading options is to buy calls and puts, that’s like telling the market to just take your money and pay you back “someday, maybe … if you feel like getting around to it.”

The truth is, every second you own that option contract is like the second hand of a bomb counting down to zero… blowing up into a useless piece of paper.  Why would anyone want to trade options when the deck is stacked against them?  Most options traders think of buying options as having “Stocks on Steroids” in their trading accounts.  The sad reality is, they continue to cling to that hope, even while they continue to lose money . . . trade after trade (after trade…).

What Happens to All Those Losing Trades, Anyway?

You know that for every option trade, there are two sides.  Buyers can’t buy without sellers.  If the options you buy aren’t making you money, you can be certain that the sellers are PROFITING CONSISTENTLY from your losing trades.  It’s time to turn the tables … literally. When you move to the other side of the trade, you put those odds squarely back in your favor.  That’s how the pros trade . . . taking your money every single time you buy a call or a put.  But by becoming an option seller, too, you will understand why the pros prefer their strategy. For starters, you’ll probably quickly get addicted to collecting COLD, HARD cash upfront on every trade.

And, the “secret” to selling options is that you enter a trade that has a 99% chance of winning. They’re practically GIVING MONEY AWAY on the exchanges. It’s true – the market pays you to make your trades!  Not quite sold on selling yet?  If watching your account grow practically on command isn’t enough, let’s look at how simple it is to keep the returns flowing in. …

Generate a Paycheck for Life …

You can sell option contracts again and again and again … for as long as you need or want to collect a monthly “bonus” without working harder — or at all!  Consider this . . .You could continue to fight the system and trade options in hopes of the next big MONSTER TRADE (the lottery ticket).  Or, you COULD pay yourself FIRST – bringing in $500 each week (or more).  Why not turn the tables in your FAVOR . . . and sell options like a PRO?  Stop trying to hit home runs by “buying options,” and start hitting singles and doubles to score more runs over time.

Five CEFs with 10% Yields

Can you still get a 10% annual dividend yield in today’s market?  Yes.  We scanned the CEF (closed-ended funds) landscape to find the 5 highest yielding CEFs with monthly distributions.  All of these CEFs have an annual yield above 10%.  As you would expect, 4 of the 5 CEFs are trading at a premium to their NAV (net asset value) so you would add these stocks to your watchlist and wait to purchase on a market pullback.  These are great investments to re-invest your dividends or to create a monthly passive income.  A 10% yield will compound fast at a monthly distribution rate.  Click the image below to enlarge.

Dreyfus High Yield Strategies Fund (DHF) is a non-diversified, closed-end management investment company. The Fund’s primary investment objective is to provide high current income by investing at least 65% of its total assets in income securities rated below investment grade. The fund also provides capital growth as a secondary objective. The Fund invests primarily in fixed-income securities of below investment-grade credit quality. Issuers of below investment-grade securities may include companies in early stages of development and companies with a highly leveraged financial structure. The Dreyfus Corporation (Dreyfus) serves as the Fund’s investment manager and administrator.
Alpine Total Dynamic Dividend Fund (AOD) is a diversified, closed-end investment company. The Fund’s investment objective is to invest in equity securities that provide high current dividend income. The Fund also focuses on long-term growth of capital as a secondary investment objective. In addition, the Fund has no limitations on the percentage of holdings that can be in either international or the United States companies. It invests in various sectors, including consumer discretionary, industrials, energy, information technology, materials, consumer staples, healthcare, financials, utilities and telecommunication services. Alpine Woods Capital Investors, LLC is the Fund’s investment adviser.
PIMCO High Income Fund (PHK) is a diversified, closed-end management investment company. The Fund’s primary investment objective is to seek high current income. Capital appreciation is a secondary objective. The Fund invests in a diversified portfolio of United States dollar-denominated debt obligations and other income-producing securities that are primarily rated below investment grade. The Fund seeks to invest at least 50% of its net assets in debt securities that are, at the time of purchase, rated below investment grade (below Baa by Moody’s Investors Service, Inc., below BBB by either Standard & Poor’s or Fitch, Inc., or unrated but judged by the investment manager to be of comparable quality), which may be represented by forward contracts or derivatives, such as options, futures contracts or swap agreements. Allianz Global Investors Fund Management LLC serves as the Fund’s investment manager. Its sub-advisor is Pacific Investment Management Company LLC.
Western Asset High Income Fund II Inc. (HIX) is a diversified, closed-end management investment company. The Fund seeks to maximize current income by investing at least 80% of its net assets, plus any borrowings for investment purposes, in high-yield debt securities. As a secondary objective, the Fund seeks capital appreciation to the extent consistent with its objective of seeking to maximize current income. The Fund invests in high-yield and emerging market instruments. The Fund invests in securities and distributes dividends from net investment income and net realized gains. It invests in corporate bonds and notes, collateralized mortgage obligation, collateralized mortgage obligation, collateralized senior loans, collateralized senior loans, convertible bonds & notes, sovereign bonds, sovereign bonds, common stocks, convertible preferred stocks and warrants. The Fund’s investment manager is Legg Mason Partners Fund Advisor, LLC.
AGIC Convertible & Income Fund II (NCZ), formerly Nicholas-Applegate Convertible & Income Fund II, is a diversified, closed-end management investment company. The Fund’s investment objective is to provide total return through a combination of capital appreciation and high current income. It invests in a diversified portfolio of domestic convertible securities, and non-convertible, high-yield bonds rated below investment grade. It seeks to invest at least 50% of its portfolio in convertibles. The Fund invests in sectors, such as advertising, airlines, aerospace and defense, auto components, commercial services and supplies, construction and engineering, diversified financial services, healthcare providers and services, and telecommunications. Allianz Global Investors Fund Management LLC serves as the Fund’s investment manager and is an indirect, wholly owned subsidiary of Allianz Global Investors of America L.P.

Covered Calls for Life

here are many different styles of covered call writing.  Some people never do more than write calls on stocks in their portfolio to generate additional income.  Other people buy stocks only for the purpose to write calls then sell them. Covered call strategies include active trading for directional moves, for traders with long-term time horizon and those seeking low-risk or limited risk trades.

For the conservative investor, you can write calls that are deep-in-the-money which limits the amount of risk in the trade.  This is a good strategy for those who are fearful of losing money.  For the lazy investor, they should look to a longer call time horizon that is many months out or even sell a leap call.  For the monthly income investor, they should sell calls at-the-money which expire during the next month.  This serves the purpose of creating a monthly income that is updated at the monthly expiration date.

The conclusion is that you can utilize the covered write strategy that best suites your income needs and personal investing style.  Or you can use more than one strategy to mitigate your risk level in income investing.

Covered Call Trades for May 2011

It is time to begin looking at the next month (May) covered calls at this time as April expired on Friday.  I have already started a short list of potential trades.  This list is most at-the-money and slightly out-of-money calls.  I have included the S&P Ranking as well as the volatility measures on the chart.  Here is the list. with company profiles below (click image to enlarge).

Thermo Fisher Scientific Inc. (Thermo Fisher) is engaged in serving science. It provides analytical instruments, equipment, reagents and consumables, software and services for research, manufacturing, analysis, discovery and diagnostics. The Company operates through two segments: analytical technologies and laboratory products and services. Analytical technologies segment includes pharmaceutical, biotechnology, academic, government and other research and industrial markets. Laboratory products and services segment offers combination of products and services that allows its customers to engage in their core business functions of research, development, manufacturing, clinical diagnosis and drug discovery. In April 2010, the Company acquired Proxeon A/S, a supplier of products for proteomics analysis. In December 2010, the Company acquired Lomb Scientific. In April 2011, the Company sold two laboratory testing services businesses, Athena Diagnostics and Lancaster Laboratories.
Cummins Inc. designs, manufactures, distributes and services diesel and natural gas engines, electric power generation systems and engine-related component products, including filtration, exhaust aftertreatment, fuel systems, controls and air handling systems. The Company sells its products to original equipment manufacturers (OEMs), distributors and other customers worldwide. It has four segments: Engine, Power Generation, Components and Distribution. It serves its customers through a network of more than 600 company owned and independent distributor locations and more than 6,000 dealer locations in more than 190 countries and territories. In November 2010, it purchased a majority interest in a previously independent North American distributorship. On January 4, 2010, it acquired the 70% interest in Cummins Western Canada (CWC).
World Fuel Services Corporation is engaged in the marketing and sale of marine, aviation and land fuel products and related services on a global basis. The Company operates in three business segments: marine, aviation and land. In the marine segment, it offers fuel and related services to maritime customers, including international container and tanker fleets, commercial cruise lines and time-charter operators, as well as to the United States and foreign governments. In the aviation segment, the Company offer fuel and related services to commercial airlines, second and third-tier airlines, cargo carriers, regional and low cost carriers, corporate fleets, fractional operators, private aircraft, military fleets and to the United States and foreign governments. In the land segment, the Company offers fuel and related services to petroleum distributors operating in the land transportation market, retail petroleum operators, and industrial, commercial and government customers.
Prudential Financial, Inc. is a financial services company. It has operations in the United States, Asia, Europe and Latin America. Through its subsidiaries, it offers an array of financial products and services, including life insurance, annuities, retirement-related services, mutual funds, investment management and real estate services. It offers these products and services to individual and institutional customers through third-party distribution networks. It has two businesses: Financial Services Businesses, which comprises its U.S. Retirement Solutions and Investment Management division, U.S. Individual Life and Group Insurance division, and International Insurance and Investments division, and The Closed Block Business, which comprises the assets and related liabilities of the Closed Block. On February 1, 2011, it completed the acquisition from American International Group, Inc. (AIG), of AIG Star Life Insurance Co., Ltd. and AIG Edison Life Insurance Company.
General Motors Company (GM) is a global automotive company. It develops, produces and markets cars, trucks and parts worldwide. GM also provides automotive financing services through General Motors Financial Company, Inc. (GM Financial), formerly AmeriCredit Corp. (AmeriCredit). These financing operations consist principally of financing automobile purchases and leases for retail customers. The Company operates in five segments: GM North America (GMNA), GM Europe (GME), GM International Operations (GMIO), GM South America (GMSA) and GM Financial. GM Financial is an automotive finance company. GM Financial purchases automobile finance contracts for new and used vehicles purchased by consumers primarily from franchised and select independent dealerships. On October 1, 2010, GM completed the acquisition of GM Financial. In February 2010, GM completed the sale of Saab Automobile AB (Saab). In May 2010, the Company completed the sale of Saab Automobile GB (Saab GB).
Jacobs Engineering Group Inc. is a technical professional services firm in the United States. It provides a range of technical, professional, and construction services to. The Company provides four categories of services: project services, which include engineering, design, architectural, and similar services; process, scientific and systems consulting services, which includes services performed in connection with a range of scientific testing, analysis, and consulting activities; construction services, which encompasses construction services, as well as modular construction activities, and includes direct-hire construction and construction management services, and operations and maintenance services, which includes services performed in connection with operating facilities on behalf of clients, as well as services involving process plant maintenance. In December 2009, it acquired TYBRIN Corporation. In February 2010, it acquired Jordan, Jones and Goulding, Inc.
Newfield Exploration Company (Newfield) is an independent oil and gas company engaged in the exploration, development and acquisition of oil and gas properties. The Company’s domestic areas of operation include the Mid-Continent, the Rocky Mountains, onshore Texas, Appalachia and the Gulf of Mexico. Internationally, the Company operates in Malaysia and China. Mid-Continent division is focused primarily in the Anadarko and Arkoma basins. Its Greater Monument Butte is the Greater Monument Butte field area, located in the Uinta Basin of Utah. During the year ended December 31, 2010, approximately 82% of its proved reserves and 90% of its probable reserves were located in resource plays, primarily in the Mid-Continent and the Rocky Mountains. As of December 31, 2010, Newfield had proved reserves of 3.7 one trillion cubic feet equivalent. On February 11, 2010, the Company acquired some of TXCO Resources Inc. (TXCO’s) assets in the Maverick Basin of southwest Texas.

Why Don’t More People Write Covered Calls

It is hard to understand why more income investors don’t use the covered call strategy more often.  Once you sell the call you have an automatic income amount set for you.  Perhaps the biggest reason more people don’t write calls is they are not aware of the strategy.  Unless you stagger upon the strategy or research it online, it is difficult to understand.

Most financial institutions do not mention covered calls as a strategy to their clients as they may risk losing business if clients pursue this strategy on their own.  These advisers are being paid commission on the amount of funds they manage so they have a conflict of interest with their clients.  Simply, they make money on the products you buy from them.

There is a certain amount of fear involving the trading of options.  Some resources lump together all option strategies as being too risky for an individual investor to use in their own portfolios.  Yet, these same “experts” will suggest you buy a small cap growth stock trading at a 100 price to earning ratio.

By producing cash flow from an asset DOES NOT increase the risk of owning the asset.  think about this: all investors should seek a return on their money which is cash flow.  Of course, if you are in the nail business you always recommend hammers!  You must realize that your interests are different from the financial institutions.  And you are the only one to focus 100 percent on your needs.  However, financial advisers make money when you do and when you don’t!  Your biggest decision is to rely on their advice or handle your own investing.

This blog believes in the individual investor and his ability to generate monthly income from writing covered calls and owning monthly dividend paying stocks.

Should You Continue Buy & Hold Investing?

How many people do you know who have achieved great wealth by holding their stocks for long periods of time?  There are a number of these investors who achieved staggering success such as Warren Buffett.  However, there are numerous reasons why I prefer income investing including covered calls to buy and hold.

“If anything, buy and hold is a completely reckless and irresponsible strategy.  This is why I have always preached ‘buy and homework.’  There is nothing wrong with buying a stock with the intention of owning it for years, as long as you are willing to check up on that stock every week to make sure that your investing thesis for owning it has not fallen apart.”  Jim Cramer (2007)

This is good advice from Cramer.  I can add more rationale why I prefer income investing to buy and hold investing:

1 – Stocks don’t always go up
As evidence from the last decade, stock returns can be volatile.  Over the last 10 years of the 2000 – 2010 decade, the S&P return was flat.  if you incorporate income investing into your strategy, you are still getting that money as a return that can be reinvested for more compounding.

2- Buy and hold doesn’t produce income
Stocks just lying around the portfolio produce no cash to you except for dividends assuming the stock pays a dividend.  Growth stocks may or may not be ome runs.  Do you really want to tie-up your capital in an investment that doen’s produce cash flow to you?  You can improve your cash return by investing in monthly dividend payers and writing calls against stock that you already own.

3- Is your timing right?
To make nice returns with buy and hold, you must be in the right stocks at the right time.  You must find the stocks that will appreciate in value and buy them at the right time to get a good price.  This requires a timing element in the stock market.  What if you found a stock just before the economic crisis of 2008?  You would have the right stock at the wrong time and lost money in the process.

If you prefer to hold a portion of long-term stocks in your portfolio, then you should consider writing calls against these stocks to generate additional income.  Of course, you can add some monthly dividend ETFs to your portfolio to add more income and diversification.

Should You Sell Covered Calls in an Up Market?

So the stock market is up 100% or more since the low of two years ago, should you still sell covered calls?  The answer is yes because stocks don’t move up in a straight line as there are many up and downs along the long-term trend.  Here are six reasons why you may want to consider selling covered calls in a rising market:

1 — Momentum
Maybe a stock has risen more than the market recently and the momentum traders are doubling down. In doing so they usually increase the call premiums to where they’re just too juicy to not try a deep in the money buy-write. Anybody look lately at Netflix (NASDAQ: NFLX)  Lululemon Athletica (NASDAQ: LULU),  or Chipotle Mexican Grill (NYSE: CMG)? These can be highly volatile so it is probably wise to keep the durations short (i.e. sell the near month, and not four to six months out).

2 — Pending News
Before a big news announcement, for example, Apple (NASDAQ: AAPL) with respect to Verizon (NYSE: VZ) iPhone, or any company before an earnings announcement) the option premiums tend to increase. Rather than buying into the hype, consider selling the hype by selling covered calls. The amount in- or out-of-the-money should scale with your opinion of which way the news will fall.

3 — Margin
When trading on margin you need to be extra careful. You can get hurt quickly if there is a sudden move against you. One way to increase your protection is by selling deep in-the- money calls. You may still lose money if there is a dramatic move down, but the call premium should buy you time to exit the position (if you need to) with fewer losses than you would have had if you had merely held the stock long.

4 — Taking some off the Table
Don’t be too greedy. After you’ve had a nice run in a stock it is prudent to either (1) sell a portion of the stock, or (2) write some calls against it so that if it gives back some of its recent gains you can capture some profit from the call premium. Often these can be combined by selling covered calls that are in-the-money on the portion of the stock you want to sell anyway. That way you eek out a bit more profit from the position. Or, if you’re still very bullish then try selling some near-term out-of-the-money covered calls.

5 — Partial Cover
If you can’t make up your mind whether you should cover the entire holding, then consider selling covered calls on part of your position. You’ll end up being half right and half wrong at the same time, but at least you won’t have been all wrong.

6 — Monthly Income
If you have core holdings that you plan to own for the long-term then why not write some out-of-the-money calls on them to generate some extra income (even if they’re rising in a bull market)? Depending how far out-of-the-money you choose, you may need to sell several months worth of time instead of near-month (to cover the transaction costs).

Daily Dividend Report
Follow Me on SA
Seeking Alpha Certified
Log In

Register

Lost your Password?

FREE: Profit with Cov Calls





* Email
* First Name
* = Required Field


Email Confidential - No Spam