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Trading Covered Calls by Legging In

This strategy is a variation of the out-of-the-money (OTM) covered call strategy.  When you are anticipation a market upturn such as a bounce up or your stock is in a prolonged uptrend, this strategy may work for this type of situation.  The legging in strategy is to buy the stock and then wait for the price to increase before selling OTM calls.  The legging in is related to the buy the stock (one leg) before you sell the calls (second leg) at a later date to complete the covered call trade.

This strategy can significantly increase your returns when the stock price moves up rapidly.  Then, you have a decision to make about when to sell the call.  Some traders decide that the stock will continue to rise so they do not sell the call.  Others may decide the stock is out of gas to move higher so they will
sell an OTM call for additional income.

As an example, you may purchase a stock at $52.40.  The current month 52.50 call strike is selling for $1.00.  You can buy the stock at $52.40 and sell the 52.50 call for $1.00 and get an unassigned return of 2.14%.  You don’t want to lock in your covered call trade for a low return so you wait on the stock.  To leg in to this trade, you would buy the stock and wait until its price increases to around $54.00.  At this time, the 52.50 call strike price is $2.50.  The leg in trader
would sell the 52.50 call strike if the stock was out of momentum and poised for a pullback.  This would create an assigned return of 5.01%.  This return is more than double the initial trade with a downside protection to $52.50.

The leg in trade more than doubles the unassigned return because the option premium more than doubled (from $1.00 to $2.50) as the stock price increased.  The return percentage doubled while both trades were at the same strike price (52.50).  This could be even better if the trader moves their call strike price
to 55 to let a stock continue to run up to a higher price.

So what is the trade off for the additional return?  Legging-in is a little speculative because it leaves the investor without a premium for a short time
while waiting for the stock price to increase.  Additionally, the trader does not have the downside protection while owning only the stock without selling the
call.  Lastly, the investor could be wrong and the stock never increases in price.

The bottomline is that the trader must have a solid reason for why the stock will increase in price in the short-term.  the moment this rationale is proven wrong, the trader must make a decision on how to proceed with the stock they own.

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How to take Advantage of High Implied Volatility

Implied Volatility (IV) gets high when a company has some impending event that can move the stock price.  The impending event sometimes refers to the stock as being a special situation stock.  The impending event causes the option IV to change based on the likely stock price move.  Here are some causes that increase IV:
 

  • There is a pending event such as an earnings report, FDA ruling, etc.
  • A significant news event is pending on another company in the same industry
  • The company’s industry is more volatile due to expected changes
  • The stock has a higher level of volatility so its options are more expensive
  • An aberration occurs as there is no apparent reason for more expensive options.

When a stock is already moving its price, option premium will be high.  IV will simply reflect that volatility and potentially more volatility. Options are also more expensive when a stock is in a confirmed trend.  
 
Time value that is inflated due to spiking IV will collapse when the event causing the spike arrives.  You do not want to be long an option when IV collapse as you can lose money even if the stock price doesn’t fall.  In general, you want to buy low volatility and sell high volatility.

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To use high volatility to your advantage when you are Bullish:

  1. Buy stock as options are expensive;
  2. Write covered calls to collect higher premium;
  3. Sell naked or cash-covered puts for higher premiums;
  4. Write bull put spreads for higher credits.

If you are bearish with high volatility:

  1. Short the stock since puts are expensive;
  2. Sell naked calls;
  3. Write bear call spreads for credit.

Real Estate Monthly Passive Income

For investors seeking consistent monthly income along with using passive vehicles, look at stocks with monthly dividends. Imagine, having multiple monthly income streams such as 10 or more stocks paying you each month. Then, add covered call investments from Get Rich Investments to live the life your desire.

Realty Income Corp styles itself as “the Monthly Dividend Company,” and frankly, this conservative retail real estate investment trust (REIT) deserves the title of king of the monthly dividend stocks. Realty Income has paid its investors like clockwork for 559 consecutive months and even raised its dividend for 77 consecutive quarters.

It has a yield of 3.9%, a stock is always going to be considered more risky than a bond, but Realty Income is about as close to a bond as you can realistically get in the stock market. Its cash flows are backed by long-term leases to high-quality tenants. Its properties are generally high-traffic retail sites that are mostly recession proof and “Amazon.com proof.”

We see total revenue growth of approximately 7% in 2019, moderating to 5% to 7% in 2020 driven by acquisitions, rising rents and stable occupancy. Occupancy at the end of Q4 2018 was 98.6%, near the highest occupancy rate within the past 10 years and up from 98.4% in the prior year. We estimate occupancy to remain near its historical average of 98% due to the desirable locations and non-discretionary retailer demand.

We raise our target price by $8 to $73, equal to 22.4x our 2019 FFO per share estimate of $3.26, and above the peer average of 15.5x. We start 2020’s FFO estimate at $3.40. O reported Q4 FFO of $0.73 vs. $0.61, $0.01 below consensus. Year-end occupancy increased to 98.6% from 98.4% in the prior year while rents under lease were up 0.8% for Q4 and up 0.9% for the year, which we find acceptable given O’s tenants are under triple-net leases. We continue to believe O will execute well and stick to its core competencies. We like that O has taken advantage of its current stock price and a favorable market, raising $539 million in Q4 from sale of common stock, a prudent move to help fund future acquisitions. We think long-term investors will continue to benefit from O’s predictable cash flow, but we reiterate our Hold opinion on valuation. O usually trades at a 20% premium-to-net asset value (NAV), but at its current 40% premium we would wait for a more attractive opportunity to buy.

 

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