{"id":49071,"date":"2014-03-27T13:03:14","date_gmt":"2014-03-27T17:03:14","guid":{"rendered":"http:\/\/countingpips.com\/forex-news\/?p=49071"},"modified":"2014-03-27T12:04:41","modified_gmt":"2014-03-27T16:04:41","slug":"covered-calls","status":"publish","type":"post","link":"https:\/\/www.investmacro.com\/forex-news\/2014\/03\/27\/covered-calls\/","title":{"rendered":"Covered Calls"},"content":{"rendered":"<h4><span style=\"font-size: small;\">By Dennis Miller, <a href=\"http:\/\/www.millersmoney.com\/go\/vxz3h-2\/PIP\">millersmoney.com<\/a><br \/>\n<\/span><\/h4>\n<p>The strategy I\u2019m writing about today is one of my favorite, guaranteed moneymakers. These are trades we can all easily make, requiring no capital outlay and guaranteed to make a profit or you don\u2019t make them. What\u2019s the catch? We might occasionally find ourselves lamenting how much more money we might have made.<iframe loading=\"lazy\" src=\"http:\/\/trk.caseyresearch.com\/f\/?content_id=794&amp;code=PIP&amp;editorial=covered-calls\" height=\"1\" width=\"1\" frameborder=\"0\"><\/iframe><\/p>\n<p>Experienced investors have likely figured out that I\u2019m talking about a stock option called a \u201ccovered call.\u201d Buying options is for speculators, and that\u2019s\u00a0<em>not<\/em>\u00a0what I\u2019m talking about today. I want to show you the one and\u00a0<em>only<\/em>\u00a0option trade that meets my stringent criteria for comfort.<\/p>\n<p>Covered calls:<\/p>\n<ul>\n<li>Are easily understood;<\/li>\n<li>Are easy to implement;<\/li>\n<li>Require no market timing to make your predetermined profit; and<\/li>\n<li>Require minimal time for investors to manage.<\/li>\n<\/ul>\n<p>In addition, you can calculate your profit clearly at the time of the trade (if there\u2019s no hefty gain, you pass on it); the risks are financially and emotionally manageable; and the upside potential is excellent with covered calls. Let\u2019s begin with the boilerplate stuff first before we discuss strategy.<\/p>\n<p>There\u2019s an options market that allows people to buy and sell options on stocks. Speculators have made millions of dollars trading options without owning a single share of stock. That\u2019s the wrong place to be with your retirement nest egg. I\u2019m going to show you how an average investor with an online brokerage account can supplement his income in a safe, easy, responsible, and conservative manner.<\/p>\n<p>Let\u2019s start with a basic premise: money is consistently made on the sell side of the transaction. Selling one type of option is the\u00a0<em>only<\/em>\u00a0strategy that will meet our stringent criteria.<\/p>\n<p>Before we proceed, here\u2019s a need-to-know glossary for covered calls:<\/p>\n<p><strong>Stock option.<\/strong>\u00a0An option is a right that can be bought and sold. There are markets for trading options in an orderly manner. Two transactions may occur between the buyer and seller. The first is the transaction when the right (option) is sold. The second transaction is \u201coptional\u201d and at the discretion of the buyer. If the buyer exercises his right (option), the seller is required to complete an agreed-upon stock transaction. Today we\u2019re focusing on covered call options.<\/p>\n<p><strong>Covered Calls.<\/strong>\u00a0When you sell a covered call, the buyer purchases the right to buy a certain number of shares of stock which you own, at an agreed upon (strike) price, at any time before the option expires (known as the expiration date). The option buyer is not\u00a0<em>obligated<\/em>\u00a0to buy your stock; he has the\u00a0<em>right<\/em>\u00a0to do so. You\u2019re obligated to sell the stock if the buyer exercises the option. The term for this is your stock gets \u201ccalled away.\u201d Regardless, you keep the money you were paid when you sold your option.<\/p>\n<p>There are four elements to an option transaction:<\/p>\n<ol>\n<li>the price of the option in the market (what you can buy or sell it for);<\/li>\n<li>the number of contracts (each contract is 100 shares);<\/li>\n<li>the price of the underlying stock (referred to as strike price); and<\/li>\n<li>the expiration date.<\/li>\n<\/ol>\n<p><strong>Option price.<\/strong>\u00a0This is the price the option is bought or sold for. This changes as the price of the underlying stock moves in the market and the time frame moves closer to the expiration date. Readers will see that there are two prices: \u201cbid\u201d and \u201casked,\u201d just like stocks. When you sell an option, this completes the first part of the transaction. The money changes hands and is yours to keep, regardless of what happens later. Cha-ching!<\/p>\n<p><strong>Strike price.<\/strong>\u00a0This part of the transaction is agreed upon when the option is bought\/sold. Let\u2019s assume the buyer purchased a call (a right to your stock) at a strike price of $55\/share. Should the buyer choose to exercise his option, the buyer pays you $55\/share, and you (through your broker) deliver the stock, regardless of the current market price of the stock.<\/p>\n<p><strong>Expiration date.<\/strong>\u00a0Options generally expire on the third Friday of every month. When looking at the options trading platform on any major stock, you\u2019ll find options available for several months in advance. You\u2019ll notice that the longer the remaining time, the higher the price of the option.<\/p>\n<p>At the time the stock option is bought\/sold, all of the elements above are agreed upon. The buyer has until the expiration date to exercise his option. The numbers of shares and selling price have already been determined. If your stock is called away, you\u2019ll see the cash come in to your brokerage account, and the shares will automatically be delivered to the buyer.<\/p>\n<p>Never sell a call option without owning the underlying stock; it\u2019s much too risky for your retirement nest egg.<\/p>\n<p><strong>Option contract.<\/strong>\u00a0An option contract is for 100 shares of the underlying stock. Options are sold in contracts, and the prices are quoted per share. For example, if you see an option price of $1.15, the contract will cost $115 ($1.15 x 100 shares). If a buyer\/seller wants to have an option on 500 shares, he buys five contracts.<\/p>\n<p>There are two types of options: puts and calls. We\u2019re going to discuss the only option strategy that meets our stringent, conservative criteria: selling a covered call.<\/p>\n<p>Why would an investor buy a call option? Buyers of call options are generally speculators who believe that a stock will appreciate above the strike price before the option expires. If they guess right, they can make a lot of money.<\/p>\n<p>The vast majority of call options expire worthless. The rules are simple. Don\u2019t sell an option unless you own the underlying stock. (This is referred to as a \u201cnaked call\u201d.) Don\u2019t buy options\u2014period!<\/p>\n<p><strong>A Savvy Strategy<\/strong><\/p>\n<p>We\u2019ll use a fictional company \u2013 ABC Products \u2013 for an example. Say we bought the stock in October 2012 for $40; the market price one year later (in November 2013) was $55\/share. Why would we want to sell a covered call?<\/p>\n<p>In November, ABC was $55\/share. We\u2019ll say its current dividend is $0.55\/share. The March call option at a strike price of $57 is selling for $1.10\/share\u2014twice as much as the current dividend.<\/p>\n<p>Assume that on December 20, you either called your broker or went online and brought up ABC in your trading platform. You would have seen the current bid and asked prices. Assume it sold for $1.10\/share.<\/p>\n<p>Now, one of four things could have happened:<\/p>\n<ol>\n<li>The stock didn\u2019t go over the $57 strike price, so the stock was not called away. In approximately 90 days, you\u2019d have received $0.55\/share in dividends, plus $1.10 for the option, for a total of $1.65. You just added more than double the dividend to your yield without spending a penny more of your investment capital. What do we do when the option expires? Look for another juicy opportunity for the June options and do it again!<\/li>\n<li value=\"2\">Let\u2019s take the worst-case scenario: the market tanked. You had a 20% trailing stop in place. You got stopped out at $44\u2014$11\/share lower than the November price. But wait a minute, what about the covered call? The value of the option would also have dropped and sold for mere pennies. If you got stopped out of the stock, you could have bought back the option at the same time. For the sake of illustration, say you bought it back for $0.04. You netted $1.06\/share profit. Instead of losing $11\/share, your loss became $9.94. If you didn\u2019t buy back your option, you\u2019d have had huge risk exposure should the stock jump back up. It isn\u2019t worth the risk, so you\u2019d spend the few pennies it takes to close out your position.<\/li>\n<li value=\"3\">You wanted to exit your position before the expiration date. If the stock rises above the strike price of the option, generally the price of the option will move right along with it. If the stock moved to $59\/share, you would \u201cbuy to close.\u201d The market price should be close to $2\/share; however, that would be offset by the fact that you sold your stock for $59.00 share.If the stock remained stagnant or started to drop and you wanted to exit your position, the market price of the option would decline more rapidly. You\u2019d likely buy back your option at a profit.<\/li>\n<li value=\"4\">The most difficult situation emotionally is when the stock rises well above the strike price and gets called. Let\u2019s assume that in March, ABC has appreciated to $59\/share. Your option is called at $57 (the strike price). You make a profit of $2\/share from the time you sold the option, plus the $1.10\/share for the option and the $0.55 dividend, for a total of $3.65\/share. For the 90-day time frame, you earned 6.3% on your money ($55\/share), or 24.9% on an annualized basis, net of brokerage commission. Yet we\u2019ll lament the fact that you could have made more.<\/li>\n<\/ol>\n<p>In each case, you haven\u2019t invested any more capital. You make 100% profit on the call in two cases. The worst case is you generally break even on the options should you want to exit early. In the vast majority of cases, selling covered calls is straight profit on top of your dividends.<\/p>\n<p>Here are some guidelines:<\/p>\n<ul>\n<li>Sell covered calls for stocks you own and would gladly keep.<\/li>\n<li>Sell covered calls to expire after the dividends are paid.<\/li>\n<li>Sell covered calls at a strike price above the current market price of the stock, referred to as \u201cout of the money.\u201d<\/li>\n<li>Don\u2019t lament the times your stock gets called. You took a nice profit, and there are plenty more opportunities out there.<\/li>\n<li>Use stocks that are heavily traded, as they are more liquid.<\/li>\n<li>To calculate gains for any stock and option price combination, please use our <a href=\"http:\/\/www.millersmoney.com\/go\/vxzae-2\/PIP\" target=\"_blank\">option calculator, which you can download here<\/a>.<\/li>\n<\/ul>\n<p>Selling selected covered calls is a great way to turbocharge yield without any additional investment. At the same time, it will mitigate a bit of risk. If you have a 20% trailing stop in place and the stock gets stopped out, your 20% will be offset by the profit you made on the option sale. While most investors are starved for yield, you can find yield in the safest and easiest manner possible.<\/p>\n<p>Each month, we look at the <em>Miller\u2019s Money Forever<\/em> portfolio and recommend and track covered calls on some of our positions.\u00a0If you&#8217;re not a current subscriber, I highly recommend taking advantage of our 90-day, no-risk offer. Sign up at the current promotional rate of $99\/year, and download my book and all of our special reports\u2014really take your time and look us over. If within the first 90 days you feel we&#8217;re not for you, feel free to cancel and receive a 100% refund, no questions asked. You can still keep the material as our thank-you for taking a look. <a href=\"http:\/\/www.millersmoney.com\/go\/vxzdf-2\/PIP\" target=\"_blank\">Click here to subscribe risk-free today.<\/a><\/p>\n<p>&nbsp;<\/p>\n<div id=\"xvMdV95u77zU\" style=\"clear: both;\">The article <a href=\"http:\/\/www.millersmoney.com\/go\/vxzgg-2\/PIP\" rel=\"permalink\">Covered Calls<\/a> was originally published at <a href=\"http:\/\/www.millersmoney.com\/go\/vxz3h-2\/PIP\">millersmoney.com<\/a>.<\/div>\n<div style=\"clear: both;\"><\/div>\n<div style=\"clear: both;\"><\/div>\n<div style=\"clear: both;\"><\/div>\n<div style=\"clear: both;\"><\/div>\n<div style=\"clear: both;\"><\/div>\n","protected":false},"excerpt":{"rendered":"<p>By Dennis Miller, millersmoney.com The strategy I\u2019m writing about today is one of my favorite, guaranteed moneymakers. These are trades we can all easily make, requiring no capital outlay and guaranteed to make a profit or you don\u2019t make them. What\u2019s the catch? We might occasionally find ourselves lamenting how much more money we might &hellip; <\/p>\n<p class=\"link-more\"><a href=\"https:\/\/www.investmacro.com\/forex-news\/2014\/03\/27\/covered-calls\/\" class=\"more-link\">Continue reading<span class=\"screen-reader-text\"> &#8220;Covered Calls&#8221;<\/span><\/a><\/p>\n","protected":false},"author":1,"featured_media":0,"comment_status":"closed","ping_status":"closed","sticky":false,"template":"","format":"standard","meta":{"footnotes":""},"categories":[],"tags":[],"class_list":["post-49071","post","type-post","status-publish","format-standard","hentry"],"_links":{"self":[{"href":"https:\/\/www.investmacro.com\/forex-news\/wp-json\/wp\/v2\/posts\/49071","targetHints":{"allow":["GET"]}}],"collection":[{"href":"https:\/\/www.investmacro.com\/forex-news\/wp-json\/wp\/v2\/posts"}],"about":[{"href":"https:\/\/www.investmacro.com\/forex-news\/wp-json\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"https:\/\/www.investmacro.com\/forex-news\/wp-json\/wp\/v2\/users\/1"}],"replies":[{"embeddable":true,"href":"https:\/\/www.investmacro.com\/forex-news\/wp-json\/wp\/v2\/comments?post=49071"}],"version-history":[{"count":0,"href":"https:\/\/www.investmacro.com\/forex-news\/wp-json\/wp\/v2\/posts\/49071\/revisions"}],"wp:attachment":[{"href":"https:\/\/www.investmacro.com\/forex-news\/wp-json\/wp\/v2\/media?parent=49071"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"https:\/\/www.investmacro.com\/forex-news\/wp-json\/wp\/v2\/categories?post=49071"},{"taxonomy":"post_tag","embeddable":true,"href":"https:\/\/www.investmacro.com\/forex-news\/wp-json\/wp\/v2\/tags?post=49071"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}