Get Rich - Stay Rich - Investing for Monthly Income

Posts Tagged ‘call writer’

The Biggest Mistake New Call Writers Make

Covered call trading is not like directional trading which has an objective to time the movement of a stock in the direction it is moving.  Covered writing is a game of regular, incremental returns.  The covered call writer’s objective is to collect the option premium for income without taking any damage to the downside of owning the stock.  The secret to success for the call writer is to make smaller, more consistent returns compared to a advanced option trader who makes many bets waiting for a 50% – 100% winner.  The biggest mistake by new call writers is writing a stock solely to capture the fattest time value premiums.

To improve the chances of being successful, the call writer should focus on stock selection.  The covered call trader should focus on 3% monthly returns.  However, a 15% drawdown on a trade will require 5 months of 3% returns to recoup the loss and get back to even.  This is why the Monthly Income Plan focuses on 5 star stocks signaling high quality stocks.

Why avoid the fattest premiums for a measly 3% monthly return?  The short answer is that high premiums often signal high risk, and writing calls on these options without regard to stock quality will eventually decimate your trading account.  There are two reasons that value premium becomes high enough to offer big returns:

1)   The stock is volatile and implied volatility is in line with the stock, or

2)   Implied volatility (IV) is significantly higher than actual volatility.

Simply, the higher the rate of return, the higher either actual or implied volatility (or both) must be on the options.  If two stocks had volatility of 60% we would expect the option premiums to be roughly comparable.  What if one stock had an IV of 25%?  This indicates a market expectation of less volatility in the future but it also means the investor is not getting paid for the 60% volatility risk he is taking on.  If the other stock had IV of 80% then the investor must determine what is causing the IV to be higher than the 60% actual volatility.  This usually indicates that the market is expecting some new event on the stocks such as news, announcement, earning or more.

If the IV is in line with the stock volatility, then the options are priced fairly so the decision comes down to – do you want to invest in the stock.  The rule is to AVOID stocks with spiking IV and look for a different trade.  To be conservative, look to write calls on stocks with a volatility of 40% or less.  If you are experienced and seek more income, look for stocks with volatility between 40% and 60%.  Anything above 60% I would consider high risk so proceed with caution.  You should at least look at the volatility of the stock before you invest to know what the risk of the trade may be over the coming option period.

Join the Monthly Income Newsletter voted the best value for option income trading

Follow us on Twitter – @GetRichStayRich

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%.

Join the Monthly Income Newsletter voted the best value for option income trading

Follow us on Twitter – @GetRichStayRich

You Can Help End Poverty

How To Use a Protective Put with a Covered Call

One of the basic mistakes that new covered call traders make is that they trade for the highest premium available to maximize their monthly income without looking at the amount of risk they are taking on with this type of trade.  When option premiums are high there is a reason for the increase in option pricing because of some uncertainty or increased risks.  The advanced covered call trader knows this and uses a protective put to manage their risk of loss on a high volatility trade.

The classic strategy is protect a position is to buy a put which is referred to as a “protective put.”  With a put buy you have the right (but no obligation) to sell a stock at the strike price of the put.  The protective put allows the stock owner to keep the stock but limits the amount of downsize to a lower stock price at the put’s strike price.  The stock owner no longer has price risk once the stock price falls below the put strike price as they can sell the stock at the put strike price before the option expires.
Stock investors refer to a put as price insurance as the cost of buying a put is similar to paying an insurance premium and the ownership of the put is
the insurance policy.  The management of stock price insurance is an additional cost to the trade.  For covered call investors, they must determine if it is worthwhile to buy the put as it will affect their monthly income plan.  The amount of buying a put depends on the amount of time before expiration, the strike price and the implied volatility of the put.  As you know, as volatility increases then option prices will tend to increase as well.

The table below shows an example trade with Under Armour (UA).  The stock is trading at $67.74 per share.  This example displays buying a put for protection at three strike prices: ITM, ATM & OTM.  As shown, the more in-the-money (ITM) the put then the more protection in stock price and less risk exposure in dollar terms.  The risk exposure is calculated by subtracting the put strike price from the net debit (share price + put cost).

The bottom two rows in the table show selling an ATM October call of 67.5 on UA.  You will receive $5.80 in premium for every call sold.  If you subtract this call premium from the risk exposure shown in the top portion of the table, you get the total risk exposure of the covered call with protective put trade.

Again – the more ITM the trade, the less risk exposure.  This example assumes the protective put strike price comes into play.  Of course, you would not usually use this strategy in a bull market as it is more effective during bear markets with increased levels of uncertainty.  You can also play what-if by using different
expiration months for the protective put.

How to use a protective put with a covered call

Click to enlarge

 

Covered Call Results in 2017 – You Can Make $2000 per Month

The year 2017 was another great year of total returns and monthly income. We had a call yield of 21% for our portfolio. You can’t get this level of yield from a dividend payment.

In terms of total return as tracked in the monthly spreadsheets, the average across all positions was 37% during 2017. In the past year ending 12/15, the S&P 500 only returned 20%. Therefore, we almost doubled the S&P while capturing significant alpha return. The average monthly income across our open positions was $132 for each position with 100 stock shares. If you own all positions (100 shares) you would capture $953 dollars of income per month. And if you double up you can capture $2,000 per month. You get it – $4,000 per month is achievable.

We had no losing positions in our perpetual call portfolio in 2017. We had 8 of 9 positions with returns greater than 20% and all but one with returns greater than 20% of the S&P 500 in 2017.

The table below shows the results for each perpetual covered call position during 2017. This table is the same information as displayed in the monthly tables for each position (based on owning 100 shares of stock and selling one covered call each month). This is for portfolio tracking only as subscribers will own more than 100 shares and sell like size amount of call options for income each month.

How to Generate a 10% Return in 45 Days

In our Monthly Income Report, we look for opportunities to utilize option selling to generate income. While we focus on selling cash-secured puts and covered calls on high quality stocks, we sometimes identify high return trades. We like to have 2 or more stock or company events leading to positive confirmation that the stock will continue its trend. This month we have identified a stock with a bullish technical indicator that has potential to generate a 10% return in only 45 days.

Stock: Alkermes plc (ALKS) is a biopharmaceutical company. The Company is engaged in the researching, developing and commercializing pharmaceutical products that are designed to address medical needs of patients in therapeutic areas. The Company has a portfolio of marketed drug products and a clinical pipeline of products that address central nervous system (CNS) disorders, such as schizophrenia, depression, addiction and multiple sclerosis (MS).

Alkermes just announced positive preliminary top line results from ENLIGHTEN-1, the first of two key phase 3 studies in the ENLIGHTEN clinical development program for ALKS 3831, an investigational, novel, once-daily, oral atypical antipsychotic drug candidate for the treatment of schizophrenia. ENLIGHTEN-1 was a multinational, double-blind, randomized, phase 3 study that evaluated the antipsychotic efficacy, safety and tolerability of ALKS 3831 compared to placebo over four weeks in 403 patients experiencing an acute exacerbation of schizophrenia. The study also included a comparator arm of olanzapine, an established atypical antipsychotic agent with proven efficacy.

ALKS will announce earnings on July 27 but should be positive on this news.

This stock has formed a pattern called Flag (Bullish), providing a target price for the short-term in the range of 61.50 to 62.30 (see chart below). We think the stock can hit the target price within 6 weeks or less. The price recently crossed above its moving average signaling a new uptrend has been established. While we like the upside potential in ALKS, we want to protect the downside against market changes.

Technical Setup on Alkermes ALKS

Strategy: We want to sell a covered call on Alkermes using the August 2017 60 Call. For each 100 shares of ALKS stock you buy, sell one August 60 covered call option for a $54.50 ($58.70 – $4.20) debit or better. That’s potentially a 10.0% assigned return with a 7% downside protection. If you want more downside protection, you can purchase an August 55 PUT for less than $2.00 per option.

This is a higher risk trade than we normally place in the Monthly Income Report. However, this is a nice setup with a positive news announcement, positive technical confirmation and increased premium from selling options for income.

Let more about creating monthly income here.

Kick Off Your Wealthy New Year

Today, we say goodbye to 2016 and open the door to a fresh start in 2017. This is the time of year we embark on hairy ass new goals in hope of transforming our lives. Hey, I am one of you too. I have goals to improve my health, lose some weight and more achieve community related goals. Of course, the one constant is to maintain focus on growing my investing income. My foundation for income is the PCD Income Strategy.

I use put selling to create my favorite income strategy – the Put-Call-Dividend (PCD) Income Strategy. This is simple selling puts each month on a select stock to collect monthly income. If the stock gets put to me, then I sell covered call options for more income while also collecting dividends paid by the stock. I sell call options for premium each month until the stock is called away from me. Then, I will start selling puts against the stock again. This strategy is exactly why I only sell puts on stocks I want to own – world class, strong dividend stocks.

I view the PCD Strategy as an opportunity to collect up to three separate income streams from a single stock selection. I prefer this strategy compared to the buy and hold of owning a stock that only pays dividends every quarter and may have a capital gain in the future. This prevents me from having to time the market and wait for a return. I want to create monthly income so the PCD Strategy presents the best opportunity to achieve this objective regardless of market direction.

Remember this: Someone’s sitting in the shade today because someone planted a tree a long time ago. This is your year to get started growing your income tree. Join our monthly income plan to jumpstart your 2017 goals.

How to make $3K in Extra Monthly Income

The year 2016 was another stellar year of total returns and monthly income. Our perpetual covered call strategy was a big winner.  In this strategy, we create a covered call position to sell monthly call options for income and buy a long dated put option to protect our downside risk.  The put cost is spread across several months so the cost is low per month and will only slightly diminish our monthly income.

As we close out 2016 and reset for 2017, we are reviewing the results we obtained from the perpetual covered call strategy during the past year. In terms of total return as tracked in the monthly spreadsheets, the average across all positions was 27.8% during 2016. In the past year ending 12/17, the S&P 500 only returned 12.75% and the DJIA returned 16.8%. Therefore, we more than doubled the S&P and beat the Dow Jones significantly while generated significantly more income. The average monthly income across our open positions was $152 for each position with 100 stock shares! AND this includes the cost of having a long put to protect against downside risk on each position.

The average cost of 100 shares across all positions was $5,278 which generated an average of $152 of income each month. A $50K portfolio will generate an average of $1500 per month while a $100K portfolio creates $3,000 every month! This is proof our income strategy works. We target a 2-3% return per month on average.

We had no losing positions in our perpetual call portfolio in 2016. We had 3 positions with returns greater than 40%and all but one with returns greater than 12.7% of the S&P 500 in 2015.

The table below shows the results for each perpetual covered call position during 2016. This table is the same information as displayed in the monthly tables for each position (based on owning 100 shares of stock and selling one covered call each month). This is for portfolio tracking only as subscribers will own more than 100 shares and sell like size amount of call options for income each month.

2016-covered-call-results

 

 

 

 

 

 

 

Click to enlarge chart

How to Develop Multiple Streams of Income

To achieve financial independence, you must create a level of income to cover the lifestyle you desire. There are many ways to accomplish an income to fund your life experiences. Many work during their life to save money for this purpose. Some are entrepreneurs that start businesses usually with hired managers to carry the workload to create their income. Others invest in passive investments such as rental housing. Here is a look at investing strategies to increase your earnings and create multiple streams of income.

In author Thomas C. Corley’s five-year study of self-made millionaires he found that many of them develop multiple streams of income: 65% had three streams, 45% had four streams, and 29% had five or more streams.

“Three streams of income seems to be the magic number for the self-made millionaires in my Rich Habits study, but the more income streams you can create in life, the more secure will your financial house be,” he writes.

I apply Corley’s thinking to my investment portfolio by identifying several streams of income. One passive income stream is collecting growing dividends from world class stocks. These stocks have a strong financial position, competitive market position, known brand and growing dividend history. I also invest in closed-end funds that pay monthly dividends. This create a diversification opportunity as I can add fixed income, preferred stocks and other types of investments. Lastly and probably more important, I sell options for monthly premium income. This includes selling cash-secured puts and covered calls. I love this strategy and have created a consistent, growing stream of income.

Join me in creating multiple streams of incomes to live the life you desire.

How to Get 50% of Your Stock Purchase in Monthly Income Installments

A covered call trade is a very simple instrument to increase your monthly income. The basic idea is to sell a call option for every 100 shares of stock you own.  By selling the call option, the investor receives a premium which is what our investors call monthly income or monthly dividend payments.  We sell new call options each month to create new income – month after month.  This is in addition to the current dividend paid by stocks on a quarterly basis.

Here is an example of what subscribers to the Get Rich Monthly Income Plan achieved in 2013:

Subscribers purchased Holly Frontier in January 2013 for $46.35 per share. So purchasing 100 share of stock will cost a total of $4,635 plus commission costs.  At this time, HFC was paying a $0.30 per quarter dividend for a dividend yield of 2.59%.  This is a nice yield on a fairly stable stock but it gets even better.  In addition to the $1.20 in quarterly dividends, HFC paid $2.00 more per share in special dividends.  This increases the total dividends to $3.20 per share in 2013.  The addition of special dividends increases the stocks annual dividend yield to 6.9%.  Wow, a 6.9% dividend yield is great in this low yielding stock market!

But it gets even better for Get Rich Monthly Income Plan subscribers.  They sold a call option on each 100 shares of HFC stock they owned each month of 2013.  Based on our results, this created a total of $1,985 for the entire year.  This created an average monthly income of $165.42 by selling the call option which created the covered call trade.  The total premium income of $1,985 is about 40% of the total cost of entering the trade – $4635 at the beginning of the year.  Therefore, investors received nearly half of their initial investment in HFC back during the year through a simple monthly covered call trade.

Now, subscribers can add the three sources of income – quarterly dividend, special dividends and covered call income together to create a Monthly Income Plan.  In total, subscribers received $2,305 in additional income from owning 100 shares of HFC stock in 2013.  This is an average of $192 in additional income each month of 2013. And, the $2305 in income is 50% of the total amount of the initial investment in 100 share of HFC!

Covered Call of Month – October Expiration

For subscribers to the Get Rich Monthly Income Plan, the monthly covered call trades all provided positive income from the selling of call option.  One of the better trades was FedEx (FDR) as the setup is shown below.  The covered call trade used a strike price of 120 as the stock closed well above this price on 10/18.  The trade provided a one month gain of 3.9% for covered call traders.

 

Covered Call on FedEx (FDX)

STRATEGY: Look at the Oct 120 covered call. For each 100 shares of FDX stock you buy, sell one Oct 120 covered call option for a $114.53 (116.83 – 1.30) debit or better. That’s potentially a 3.87% assigned return.

TREND:   The technicals for FDX are bullish with a strong upward trend. The stock has support at $107 and is above resistance. The company reported earnings today, Wednesday, September 18. S&P rates this stock 4 STARS (out of five) – buy.

BLANKET PUT: As a protective option to the covered call, you can buy the Jan 2013 110 Put for $3.20 to limit your stock downside to $110.00 per share. This put is not required for the covered call trade but serves as additional protection for those seeking to limit downside. You should sell the put when you exit the covered call position.

 

RESEARCH NOTES:  S&P maintains buy opinion on shares of Federal Express (FDX). We keep our FY 14 and FY 15 EPS estimates at $7.04 and $8.66. We raise our 12-month target price by $10 to $127, 18X our FY 14 estimate and towards the middle of its 10-year historical range of 9X-34X reported EPS. Q1 EPS of $1.53, vs. $1.45, is $0.02 below our estimate but $0.03 better than the Capital IQ consensus. FDX reaffirms FY 14 guidance of EPS growth of 7%-13%. We expect FDX to benefit from an improving global economy and its ongoing restructuring plan, and anticipate continued investor rotation into logistics stocks on good economic news.

Free Traffic Generation
Subscribe for FREE Trades

Subscribe for FREE Trades

* indicates required
/ ( mm / dd )
Archives