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The time has come for the average investor – either wealthy or in the process of accumulating wealth – to consider using covered calls. We’ve been using them in our High Yield Trader portfolio over the past 19 months with great success.
After I go over the basics of a covered call strategy I want to show you exactly how we have managed to, at least, triple the dividend in each of the blue-chip companies held in our High Yield Trader portfolio.
So what is a covered call?
Covered calls are an options strategy whereby an investor holds a long position in an asset and writes (sells) call options on that same asset in an attempt to generate increased income from the asset.
The strategy is often employed when an investor has a short-term neutral-to-bearish view on the asset. For that reason, he or she decides to hold the asset (long) and simultaneously have a short position via the option to generate income from the option premium. Covered calls are also known as a “buy-write” strategy.
For example, let’s say that you own shares of Wal-Mart (NYSE: WMT). You like the stock’s long-term prospects as well as its share price but feel in the shorter term the stock will likely trade relatively flat to lower, perhaps within a few dollars of its current price of roughly $78.50. If you sell a call option on WMT for $81 with 45 days left until expiration, you will earn a premium of $70 per options contract, but cap your upside gain at $81.
By collecting $70 per contract you will make roughly 0.9%. I know 0.9% doesn’t seem like a lot, but we need to remember that we can make a similar transaction every 45 days, or approximately eight times a year, for a total of 7.2%. The 7.2% return is triple the 2.4% dividend currently offered by Wal-Mart.
One of three scenarios is going to play out:
a) WMT shares trade flat (below the $81 strike price) – The option will expire worthless and you keep the premium from the option. In this case, by using the covered-call strategy you have successfully outperformed the stock.
b) WMT shares fall – The option expires worthless, you keep the premium, and again you outperform the stock.
c) WMT shares rise above $81 – The option is exercised, and your upside is capped at $81, plus the option premium.
As I have often stated, most investors think of options as high-risk, speculative strategies where large losses can be incurred. While this is certainly true of some options strategies, covered calls are actually more conservative than investing in ETFs or stocks alone.
In other words, a covered-call strategy is SAFER than buying a stocks or an ETF.
Why?
Because covered calls:
- Provide some protection in a down market
- Are one of the few ways an index investor can achieve double-digit returns in a flat or slow-growth market
- Lower your cost basis while decreasing the volatility of your portfolio
Remember, covered calls make money when stocks are slightly higher, flat or down. You only get the underlying stock “called” away if it rises significantly.
So again, why would any investor choose to shy away from such a proven income strategy that has outperformed the market and dividend-paying stocks over the long term?
We’ve been selling covered calls and puts in the High Yield Trader for incredible returns since April 2013. If you would like to know more about how we use our unique income strategies please make sure to join our live event this Thursday. Ian Wyatt and I will be discussing covered calls as well as one of my other favorite income strategies, selling puts. In addition, we will be giving away four trades.
So tune in if you would like to get started on what I feel are two of the best alternative income strategies offered in the investment universe.
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