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How To Use Moving Averages in Covered Call Selection

The use of moving averages are important to assessing the price trend of a stock.  Even better is using multiple moving averages to increase your accuracy of identifying the stock trend.  The definition of a moving average is the average of the stocks closing price over a period of time. As a new closing price is made, it is added to the calculation and the oldest closing price is removed from the calculation. This creates a new data point on the moving average as this process continues into the future.

The simple moving average (SMA) is the total of all closing prices for the time period divided by the number of points in the period. The exponential moving average (EMA) weighs more recent closing prices higher than older data prices as the newest data point is more relevant than older price points.  the EMA is more sensitive than the SMA but it has more frequent false signals.

I prefer to use the 20-day SMA and the 50-day SMA in my price charting.  There is nothing magical about these SMAs as other investors may use a 14-day and 40-day SMA.  I like the 20 and 50 day SMAs as a 20-day is 4 weeks or one month based on closing prices and the 50 day is 10 weeks. I usually sell the current month so the 20-day is more suitable to a one month call option while the 50-day serves as my longer term marker.

What should you look for in moving averages?  First, any time one SMA crosses the other the trend has changed (see chart below).  When the 20-day crosses ABOVE the 50-day, then the stock is starting an uptrend.  Conversely, if the 20-day crosses BELOW the 50-day the trend is moving down. The predictive factor happens when the stock price gaps way above the 20-day SMA as this signals a pullback for the stock.

The best covered call candidate will have the 20-day SMA above the 50-day with a flat or uptrending price line.  If the 20-day is below the 50-day, I usually pass on the stock as there are so many other stocks better suited to a profitable covered call trade.

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Want To Create A Second Income?

Get Rich Investments, an online leader in helping individuals to create income producing investments, has a newsletter to guide investors seeking a second income.  This is one of the most valuable tools for investors to learn how to create monthly income from stocks and option strategies.

Does the idea of using an income investing strategy to create a second income every month on your funds appeal to you?  Get Rich Investments has created the Get Rich Monthly Income Plan to teach individuals how to create multiple streams of investing income.  This is a low-cost newsletter providing the following services:

    1. A list of “monthly dividend stocks” that pay dividends month after month. These investments can pay more than 10% annually (focus on several 15% yields) and can sometimes be purchased at a discount to net asset value.
    2. A list of covered call trades consisting of high quality stocks such as the S&P 5-star research rating of the best stocks that are recommended as strong buys. These lists are updated each week with select trades added daily.
    3. Low risk investments to minimize market risk and to prevent your portfolio from taking a big lost in such uncertain market environments like we are experiencing today.
    4. We have created a strategy called the Blanket Put that will protect your investment from market downturns. The Blanket Put is your safety blanket to protect your portfolio from market downturns. This is worth the membership fee by itself.
    5. Access to multiple education resources to better learn how to be a more successful investor. Trades don’t end when you make a stock buy, sell a call, or complete the trade. Here we want members to be educated about how to manage a trade and when to take action.

The Get Rich Monthly Income Plan diversifies risk by seeking multiple streams of income. You can create monthly income by: covered call trades, monthly dividend stocks and dividends from owning high quality, conservative stocks. That is multiple streams of income from this simple list as we focus on “cash flow” to the investor to improve your quality of life. This is a true passive side hustle for income.

We have more than 20 years experience in the markets including trading covered calls and monthly income investments.  In addition, we have Masters in Business Administration (MBA) from a top business school and other experience in corporate finance and strategy.  We have authored several books including the original Get Rich – Stay Rich: Investing for Monthly Income that is currently on sale at Amazon and other bookstores around the world. It is important to you that your monthly income is in qualified, experienced investor hands who can be trusted to deliver the best trades.

Learn more about investing for income.

The Best Method for Call Writing

Most experts in the stock market will generally say, “the writer of an options is foregoing any increase in stock price that exceed the strike price for the premium received when selling calls.  The option writer continues to bear the risk of a sharp decline in the price of the stock. The cash premium will only offset this loss.”  Do you buy into this way of thinking?  This is not correct based on how I trade covered calls.

With my method, you no longer care about the price of the stock that you purchased.  When the stock does go down, we would buy back the option at an inexpensive cost and immediately write a new option.  For example, we received a premium of $3.00 and close it at $0.25 when the stock price drops.  If the stock price went down $5.00, we would write a new call at at a $5 lower strike price.  This may net an addition premium of $3.00 so when you add the premiums minus the buy back of the first option we have $5.75 while the stock only dropped $5.00.  The second premium helped to offset the loss from the strike price.

When the stock does not reach the strike price, let the option expire, keep the premium, and write a new cal at the same strike price.  When the stock price goes above the call strike price, buy back the call option and write a new option at a higher strike price to reflect the gain in the stock. the second premium will help defray the cost of the buyback while you have a gain in the stock price.

For the buyer, options are a wasting asset as time decay erodes value.  The time value portion of a option is always zero at expiration.  Selling the time value repeatedly on the same stock makes option income work for you.

With my trading method, you will not be waiting on the stock price to go up to make money.  You will make money on the wasting time value of options you have sold.  this will change your investing philosophy about the stock market.

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How to Determine Stock Price Trend for Call Writing

A stock can go up, go down or hold it’s trading price in a tight channel. For the covered call trader, you can look at this by different levels such goes up a little, goes up a lot, goes down a little and goes up a lot. The writer makes money if the stock goes up a little and a lot. The call writer will also make money if the stock hold it’s price and maybe if the stock goes down a little. The greatest concern to call writers is if the stock goes downs a lot. This is where a call writer can lose a significant amount of capital.

To determine what trend the stock is in before buying, look for these three trends on the stock chart:

Uptrending: the stock is in an uptrend when it is making higher high and high lows. The stock price will be rising higher from left to right on the chart.

Downtrending: the stock is in a downtrend when is is making lower highs and lower lows. The stock price will be moving lower from left to right on the chart.

Channeling- the stock is trading in a sideways range between price support and resistance levels. If you draw a line above the recent highs and below the recent lows it will be two horizontal parallel lines.

There are some charts that are so volatile that they cannot be characterized at all. The simple rule is if you can’t determine the stock price trend then pass on this stock as a covered call candidate. You do not need to be an expert at reading stock charts to be successful. If you can get the trend direction correct then you will have more consistent trading profits.

Learn more about call writing.

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Should You Sell Covered Calls in an Up Market?

So the stock market is up and at record highs, 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. 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), 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).

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How To Get Paid Monthly Royalties

A royalty trust is a type of corporation usually based in the United States or Canada.  In general, trusts usually own oil and natural gas wells, rights to wells or rights to the mineral deposits.  Royalty trusts are similar to real estate investment trusts (REITs) as they are tax free if they payout 90% of income to shareholders.  Most royalty trusts trade on major US stock exchanges.  Others trade in Canada and have a pink sheet listing in the US.

So many corporations were using the trust advantage that Canada changed the regulations starting January 1 2010.  This will force some trusts to convert into a regular corporations which will lower their dividends.  However, this does not  lower their status as monthly income stocks.

Non-Canadian investors owning a Canadian royalty trust is subject to a foreign income tax of 15% of payouts.  This 15% tax can be claimed on US taxes from a Form 1099.  This makes Canadian royalty trusts better investments for taxable accounts in the US.  In non-tax accounts such as an IRA, you will be double taxed by Canada upon distribution date and US when funds are withdrawn from the IRA.  The US royalty trusts do not have a 15% foreign tax so they can be held in tax-deferred accounts.

Over the last six months, there has been a significant quest for high yield investments.  This has decreased the yields on trusts from double digits to single digits because of the increase in share prices.  This lessens the appeal of royalty trusts at time.  It would be better to patiently wait for a market correction to initiate a new position.

Here is one to consider:

Cross Timbers Royalty Trust

TICKER: CRT

MARKET VALUE: $91.7 million

DISTRIBUTION YIELD: 9.9%

Cross Timbers Royalty Trust (CRT, $15.09) has existed since 1991 and earns royalty income from Texas, Oklahoma and New Mexico drilling properties. Most of the trust properties are located in the prolific San Juan Basin and all are owned and operated by the XTO Energy subsidiary of Exxon Mobil (XOM). Production comes from 4,900 oil and gas wells spread across nearly 60,000 acres.

Reduced gas production and higher development costs in 2017 caused trust distributable income to decline by 5% to $6.05 million, or $1.009 per share. Production volume and the monthly distribution have been erratic in 2018. Cross Timbers has paid out 82.5 cents per share to investors through seven months. As long as the average holds steady, CRT should pay out roughly $1.41 – a 9.3% yield that’s actually less than the projected forward yield using the most recent distribution.

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Getting High Yields from Closed-End Funds

This is the second in the investing for monthly income series: how to get high yields from closed-end funds.

What is a closed-end funds (CEF) and how is it different from other investments? A closed-end fund is legally know as a ‘closed-end company.” It is one of three investment types of investment companies. The other two are mutual funds and unit investment trusts. Unlike mutual funds, closed-end funds sale a fixed number of shares at one time that trade on the major stock exchanges such as NYSE, NASDAQ, etc.

The price of CEFs are set by the market and can be above or below their net asset value. Generally, CEFs do not redeem shares from investors as the shares are bought and sold at market value on the exchanges.

CEFs come in many varieties with different objectives, strategies and payment time frames.  These funds can easily be purchased through any discount brokerage in both taxable and tax-deferred accounts.  The CEFs we are interested in pay monthly dividends and provide a high yield. When these funds trade at a discount (share price is lower than net asset value), their dividend yield is higher. This creates an opportunity for potential capital gains in addition to monthly income.

Upon receipt of monthly dividends, you can reinvest some or all into more shares of CEFs or other dividend investments. Reinvestment of dividends creates a compounding effect that will grow your income each month. There are rumors that former President Bill Clinton receives $84,000 per month in dividend income. This is a large supplement to the $16,750 Clinton receives from his government pension per month. This is one method that helps the rich get richer. However, you can accomplish the same objective by investing for monthly income.

Where can you find a list of CEFs? I personally use CEF Connect to track a list of CEFs in a portfolio. This is a free service (requires registration) with a search engine that will separate monthly payers from the flock. At last count, there was more than 400 CEFs that pay monthly dividends. There is a comprehensive list in Get Rich – Stay Rich.

The best time to buy CEFs is when they pull back in share price. The one caveat is to ensure their earnings per share is more than their dividend payout (this is available at CEF Connect under the distribution tab). If not, then you should sell and evaluate another CEF. The other item to watch is that the CEF pays distributions from ordinary income and does not pay from return of funds. Any return of capital means the CEF is giving back capital in the form of dividends which means the company did not earn their pay. Sell immediately if you see a return of capital.

The more you research CEFs, the more you come to like the total return and consistency of monthly paychecks. Keep in mind that financial independence is replacing your current income with passive income. CEFs are one investment to help get you closer to living a life within your comforts.

Here are two preferred stock CEFs for consideration:

The AllianzGI Convertible and Income Fund 5.62% (NCV) cumulative preferred stock is now trading in the $24.61 area to give it a current yield of 5.71%. This issue is rated AAA by Fitch. The issue had an excellent asset coverage ratio of 353% when it last reported.

AllianzGI Convertible and Income Fund II 5.50% coupon preferred (NCZ) is trading in the $24.04 area to offer a current yield of 5.73%. With a rating of AAA from Fitch, it a very safe issue. This CEF issue has an asset coverage ratio of 368% at last report.

Most of the CEF preferreds from Gabelli are now trading with current yields in the 5.2% to 5.3% range, indicating that the AllianzGI issues are relatively underpriced and present a good opportunity to purchase the safety of a AAA-rated preferred stock issue.

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A 20% Dividend Yield from Small Caps with Monthly Dividends

Small-caps have been on a tear in Q2 clearly outperforming its larger counterparts. President Trump’s protectionist agenda and the resultant trade war fears started weighing on large-cap stocks that have considerable international exposure. And the domestically focused pint-sized stocks soared

In additions to trade tensions, there were some other factors that played their roles in pushing pint-sized stocks higher. The U.S. economy has been on steady ground. This gave a boost to small-cap equities. Apart from this, upbeat earnings sent small caps rallying in recent times.

And what could be better than a high dividend feature attached to this segment? The fund yields about 20.45% annually.

The UBS ETRACS Monthly Pay 2xLeveraged US Small Cap High Dividend ETN (SMHD) is linked to the monthly compounded 2x leveraged performance of the Solactive US Small Cap High Dividend Index, less investor fees.

This is a relatively new ETN released in late 2018. It does carry risk being in the small cap area, being leveraged and with such a high yield. However, it can offer diversification to a high yield portfolio especially since it tracks small caps that usually don’t produce yield. It is trading 30% below its stock price high for the year.

Leveraged ETNs have interest-rate risk since they implicitly borrow at short-term interest rates to finance their leverage. A significant part of their high dividends results from the carry that is generated when the dividends paid by the securities in the indices upon which the ETNs are based exceed the implicit borrowing rate. While typically called dividends, the payments from ETNs are technically distributions of interest payments on the ETN note based on the dividends paid by the underlying securities that comprise the index, pursuant to the terms of the indenture.

As with all investments, you should be conservative with the total percent of your portfolio allocated to high risk. I like to have a few high yield stocks rounding out my monthly income plan. SMHD is in my personal portfolio as I believe the dividend is sustainable. Over time, the yield will compensate for the increased volatility and risk.

I am working on creating several new portfolios. The one most exciting is the monthly income stocks as a income resource to reach financial independence with passive (side hustle) income. I will hae more to come on this opportunity.

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How to Invest for Monthly Dividends

This is the first in a series of articles based on types of vehicles that pay monthly dividends.

Many people have the desire to increase their monthly income which leads to various activities to accomplish this objective. They may work extra hours at their job, start a side business or stuff envelopes for a few extra dollars. These tasks are all legitimate ways to make more money. But most are not aware of the simple way to increase monthly income by getting monthly dividend checks.

Truth is that many people don’t realize that this is a great time to invest in dividend securities. Yes, the market was scary throughout 2008 and 2009 as the markets tanked and the economy sunk into a recession. Unemployment reached double digits in many areas across the United States. During volatile times, investors watch as their growth and technology stocks get hammered until they reach new lows in price. However, the best time to invest is when there are signs of an improving economy. This is what has happen over the last six to 12 months as the markets started trending up and stock prices reached new 52-week highs.

So why would you invest when the market has already started to recover? During the economic meltdown lead by the imploding debt crisis, companies started to batten down the hatches by conserving their cash. During the last few quarters, companies in the S&P 500 had more cash and current assets on their balance sheet than in the last decade. There are several things companies can do with this cash. But the one that is of interest to us is companies using the cash to increase dividends. Therefore, if you purchase stock in a stable company, there is a better than average chance that the dividend will increase in the future.

This increase in dividends will be a positive for many investments that pay monthly dividends. The result being that your dividend yield on cost increasing over the next few years. Generally, when dividends increase the share price will follow. the investor will have more income from the dividend increase and potential for a capital gain if share prices increase. This is the reason why now is a good time for dividend investing.

How do you invest for monthly income? Today, there are several investment vehicles designed to pay monthly dividends. These include closed-end ETFs, business development companies, royalty trusts, REITs and even high-yield corporate bonds. As we progress through this series, each of these investments will be examined in greater detail with specific company names that are potential investments paying dividends of 10% of more. Yes, some of these investments pay at or above 15% yields today.

Here is a couple monthly dividend payers to consider:

Global Net Lease (GNL)

Dividend Yield: 11.22%

Global Net Lease (NYSE:GNL) is another REIT, primarily serving the commercial market. It owns properties in the United States and Europe, and rents to quality tenantslike FedExFamily Dollar and ING Bank, organizations that can not only reliably pay their rent as it comes due, but outfits that tend to stay put once they establish roots.

There’s a bit of a twist Global Net Lease brings to the table that allows it to juice its payout to its current yield of 11.22%, however. It also acquires much of its rental real estate through an arrangement called a sale-leaseback.

In simplest terms, a sale-leaseback lets a property-owning company free up the value of real estate by selling a space it owns to a landlord like Global Net Lease, and then remain in that space as a tenant. It’s a win-win scenario, as the renter enjoys a big cash infusion and Global Net Lease has a tenant already lined up.

Horizon Technology Finance (HRZN)

Dividend Yield: 10.23%

Finally, Horizon Technology Finance (NASDAQ:HRZN) has earned a spot on a list of monthly dividend stocks to mull. As the name suggests, Horizon Technology Finance provides capital to young, upcoming technology outfits, though it doesn’t cater strictly to the tech sector.

It’s also heavily involved in the development of life science and biotechnology companies. Its portfolio includes biotech names like AccuVein and Celsion, along with traditional tech plays like cybersecurity company Control Scan and communications technology player Xtera.

Its results are as erratic as what you’d expect from major technology names, but it’s worth the wild ride. Horizon’s yielding 10.23% at its current price, and it has not had any sustained trouble affording its dividend payment.

Learn more about investing for monthly income here.

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Adding a Put to a Covered Call

When you buy a put for a covered call trade, you then have both a sold call and bought put on the stock you own.  This is called a “collar” as you have a  protective put on a covered call.  The classic collar has an at-the-money (ATM) call and put at the same strike price.  In the case of the covered call trader, the  bought put serves as additional downsize protection against a stock price decline.

When you add a put to a covered call trade, you are adding additional cost to the trade.  This will increase your cost basis for the trade. However, you can create a totally riskless covered call trade.  Let’s look at an example using XYZ.

XYZ is trading at $74.77 in the market.  You can sell the 75 Call for $4.20 and buy the 75 Put for $4.00.  If the stock is above 75 at closing, if will be called away and you gain $0.43 in profits (75-74.77+.20).  Additionally, we could sell the put if there is any value left before expiration.  In this scenario, you make money from the covered call side.

If XYZ is trading below 75 at expiration, the call will expire worthless but the put will have value.  You would exercise the 75 put which will give you $75.00 for the stock shares trading below the 75 strike price.  You would then make a profit of $0.43 on the protective put side of the trade.

XYZ
Stock Price         74.77
Sell 75 Call           4.20
Buy 75 Put           4.00
Net Premium           0.20
Net Cost         74.57
Downside Risk                –
Max Profit           0.43

 

This trade is a risk-free trade because the total cost basis ($74.57) is below both strike prices of 75.  Regardless of what happens to the stock price, you will receive $75.00 for your stock. You can say that this collar trade is an arbitrage trade because there was a positive difference between the call and put prices at the 75 strike price.  The return of $0.43 is only a 0.58% return.  When you add trading commissions to the cost basis, this can’t be arbitraged by a retail investor.  For more active traders, you can vary your timing of closing the call and put sides to increase your profit.  For example, when the sold call loses the majority of value, you can close this side by buying to close the call.  Then, you will own the stock with the put guarentee at the strike price.  There are numerous possibilities when you actively managed the collar trade if you make adjustments before expiration.

You can construct a similar trade with different strike prices for the call and put.  When you vary the strike prices this, you are changing the cost basis and risk exposure.  For example with the 75 covered call on XYZ, we might buy the 72.5 put for $3.15 (see table below).  This will give us a max profit of $1.05 and downsize risk of $1.22.

XYZ Stock
Stock Price         74.77
Sell 75 Call           4.20
Buy 72.5 Put           3.15
Net Premium           1.05
Net Cost         73.72
Downside Risk           1.22
Max Profit           1.05

 

The great part about this type of trade is that you are limiting the amount of downsize by using the blanket put.  If the stock market bottom falls out with a 10% correction, you will only lose $1.22 per covered call or 1.65%.

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