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Proof that Option Income Writing is a Winner

With a covered call and protective put strategy, you have a win – win- win –win situation.  Here is what happens when the underlying stock changes:

  • Stock price increases –      you win by keeping the premium and either rolling up your call to a higher strike price or letting the stock get assigned;
  • Stock price is unchanged – you win by keeping the premium and possibly the stock to write more calls against it in coming expiration months;
  • Stock price slightly declines – Your amount of premium received will cover a slight decrease in the stock price so you win and keep the stock for more call writes for income;
  • Stock price declines aggressively – the protective put will gain value as stock prices decline closer or through the put strike price while you keep the premium and stock for more writes.

If you use the covered call with a protective put, you can create a great wining trade.  This is better for writing calls against a stock several months as this will offset the cost of buying a put for protection.  The protective put should be at least six months ahead of the current call expiration month when initially purchased.   This allows the investor to spread the put cost over the six month period to increase the profitability of the trade.  For example, if the protective put cost $300 to buy, the cost will average $50 per month on average.  However, if you exit the covered call position before the put expires, you can sell the put to recoup some of its cost.

In the case of a significant price decline, the put will become more profitable as it will increase in value.  The call writer can buy back the sold call
for pennies and sell a new call at a lower strike price to get more premium income.  After a few months of this, the trade should be profitable.

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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.

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How To Manage A Covered Call Portfolio

We create multiple streams of income to achieve financial independence and early retirement. Learning how to get rich trading covered calls is what we do here.

The option income portfolio approach to selling covered call options seek to do the following:

  • To create options portfolios with the objective of earning consistent returns on investment throughout the stock market cycle;
  • To maximize options premium income, dividend income, capital gains potential and downside protection;
  • To increase long-term capital appreciation and income from stock ownership;
  • To minimize risk and provide diversification.

The option income portfolio is a continuous investment strategy.  Stock should be owned and options sold.  Dividend and option premiums can be earned and capital gains increased.  This is a key step in successful investing.

The more active you are, the greater you potential returns will be.  For example, when a sold call’s market value drops to 10-20% of the call premium received when initially sold – the investor should buy to close the call and then write a new call for more time value and/or at a different strike price.  This makes the covered call strategy more continuous and more profitable.

The experienced covered call investor will not panic when the stock price exceeds their call strike price.  They will buy to close the sold call for a loss and sell a new call at a higher strike price.  The loss will be covered by the additional call premium and the potential capital gain of the increased stock price.  The loss from the initial call buyback is a taxable loss for your income tax statement.  The loss is calculated by subtracting the cost of the buyback from the initial call premium received.  The investor should always keep a running log of these buyback transactions that result in a trading loss for income tax purposes. Like any losses over the allowable $3,000 in annual investing losses, they can be carried forward.

As an individual investor, you may not have time to manage a covered call portfolio like described above.  This is OK as you can still create a covered call portfolio for monthly income.  As you gain more investing experience, you can move in the direction of being more active in managing your covered call investing.

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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.

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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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Get Money for Nothing and Your Stocks for Free

Covered calls generate income through call premium received and lowers the risk in the underlying stock position.  Obviously, the risk of owning a stock is the price you paid to purchase the stock.  Anytime the stock drops below the price paid to purchase the investor is now in a losing position.  If you purchase a stock that pays dividends, then dividends collected lowers the purchase price of a stock.  For example, you purchase FirstDividend stock (fictional name) for $30 that has a 3.0% dividend yield.  The dividend will be $0.90 per year or $0.23 per quarter. After the end of year one, your adjusted share price in FirstDividend will be $29.10 ($30-$0.90).  At a yield of 3.0%, your investment will double in 24 years just on the dividend without an increase in share price.

Now, let’s add a covered write to the stock each month.  For example, you can sell a $31 call at $0.75 that expires in 30 days.  Assuming that we don’t get called out, this will total to $9.00 at the end of year one if we continue to sell a call each month for the $0.75 premium.  This will drop the adjusted share price from $30 to $21 or 30% less than the price paid excluding your dividends.  This will double your investment in First Dividend in 2.4 years based on the call premium received each month.

If you combine the call premium with the dividend, then the adjusted stock price will be $20.10 at the end of year one.  This will further lower your time to double to 2.18 years.  This means that at the end of 2.18 years, you will have your total investments returned to you excluding any share price change or dividend increases and still own the stock.  This is a great benefit of selling calls against the stocks you hold in your portfolio.  In the first year alone, you will have received $990 in income for each 100 shares of stock you own.

The trade-off in writing calls against stock you own is that the topside is capped at the strike price of the call sold.  Therefore, you are at risk of selling your stock at the strike price which limits potential upside share price appreciation.  This should not be a problem for the investor that is seeking monthly income.  You must commit to writing calls for monthly as your chosen strategy to make monthly income and not be concerned that the share price will increase in a month.  Of course, if the stock gets called away then you can sell puts to get back into the position.  The put premium will serve to lower your adjusted share price just like the call premium in the example above.

You can continue the income cycle by selling puts to buy stock then sell calls when you own the stock.  Each month you are lowering your adjusted purchase price until you get your investment back and have a $0 cost in the stock.  All the while you are creating monthly income from your investment.  The end result is that you get your money for nothing and your stocks for free.

We continue to identify winning option trades to generate income and to exit early as the stock bullish patterns moves prices higher. Try our monthly income plan as you will definitely enjoy the extra cash.

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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.

A Covered Call Trade on Microsoft

Investor sentiment turned strongly bearish recently as emerging markets were hit by both country-specific problems and the realization that the Fed’s trimmed bond-buying program reduces the liquidity that has boosted higher-yielding emerging market assets and put a floor under U.S. stock prices.

The broad selloff in emerging markets over the recent weeks translated into the worst week for global stocks in seven months. The S&P 500 slid 2.6 percent, its largest weekly decline since June 2012.  Still, the S&P 500 is just 3.1 percent below its record closing high.  If the bears stay put, then the market could pull back over the coming months.

Due to the selling on Wall Street, investors were willing to pay more for spot protection against a drop in the S&P 500.  At this time, investors are concerned a market pullback may be overdue.

Investors should consider looking at blue chip stocks with low betas, nice dividend yields and sell some calls for downside protection and additional income.  A good choice is Microsoft (MSFT) with a current dividend yield of 2.77 percent and a beta of only 0.78.  In addition, the Company just beat earnings estimate and year over year earnings.

For the fiscal second quarter ended Dec. 31, revenue rose 14% to $24.52 billion, partly reflecting the release in November of a new Xbox videogame console and a fresh version of Microsoft’s

Surface tablet computer ahead of the holidays.

Overall, net income climbed to $6.56 billion, or 78 cents a share, compared with $6.38 billion, or 76 cents a share, in the year-ago quarter.  Analysts, on average, estimated Microsoft would post earnings of 68 cents a share on revenue of $23.7 billion, according to Thomson Reuters.

The company said its devices and consumer revenue grew 13% to $11.91 billion, while commercial revenue increased 10% to $12.67 billion.

On November 19, 2013 the board of directors at Microsoft had approved a dividend of $0.28 per share. The dividend is payable on March 13, 2014 to shareholders of record on February 20, 2014.

The stock has landed on the “Jefferies Highest Conviction Franchise Picks for Big Upside in 2014.”  Jeffries had this to say about Microsoft in this report, “With the Xbox One poised to be one of the fastest selling gaming consoles ever, the fourth-quarter sales for the company were outstanding. Investors are paid a very solid 3.1% dividend. The Jefferies price target for the software giant is $42.”

Last week, analysts at Deutsche Bank have upgraded their coverage of Microsoft to a Buy rating from a Hold, while raising their price target on the stock to $40 from $32 a share.

Also, Microsoft has an equity summary score of 9.4 out of 10 for a very bullish outlook according to a consensus of analysts.

Investors can look at selling a call option to get some downside protection and additional premium for income.  The basics of a covered call is that an investor can sell one call for every 100 shares of stock owned.

One potential covered call trade is to sell the March or April 2014 38 call option.  Under this scenario, your Microsoft shares will be called away if the stock price is above the strike price of 38 on March 22. So the investor is giving away the stock price upside as long as they are short the call.

However, investors will receive a call premium for each call sold.  This gives the investor downside protection to around the $36 price level.  Investors will also get the $0.28 dividend.  In total, this covered call trade with the cash dividend can potentially create a 5% return over the next 2 months.

Covered Call Trades of the Month

Investors have been bracing for anything that could reverse at the last minute the market’s year-long rally, which saw the Dow and S&P 500 hit record highs again this week. The S&P 500 is up 26 percent this year and registered a sixth week of gains on Friday.  However, income investors seeking to trade covered call investments have been performing well too.

Below are two successful trades from the past month listed in the Monthly Income Plan at getrichinvestments.com .  Each month, income investors are creating income streams from selling covered call options against high quality stocks.  Here are some winning trades from the current newsletter:

Covered Call on USG Corp (USG)

STRATEGY: Look at the Nov 27 covered call. For each 100 shares of USG stock you buy, sell one Nov 27 covered call option for a $25.50 ($26.65 – $1.15) debit or better.

Actions: USG is currently trading at $27.66 at the close on 11/15 so the 27 call we sold is ITM.  These shares and call options will be called away.

This is a 5.88% return for one month and an estimated 70% annualized return.

 

Covered Call on Flour Corp (FLR)

 

STRATEGY: Look at the November 2013 77.5 covered call. For each 100 shares of FLR stock you buy, sell one Nov 2013 77.5 covered call option for a $74.89 (77.19 – 2.30) debit or better.  That’s potentially a 3.49% assigned return.

Actions: FLR is currently trading at $79.36 so the 77.5 call we sold is ITM.  These shares and call options will be called away on Friday (11/15).

This is a 3.49% return for one month and an estimated 42% annualized return.

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.

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