There is a very simple way you can make more money with less risk when you buy a stock. In fact, you could be making 32% more a year on your stocks with one simple strategy.
This strategy is available to just about every investor on the planet, yet very few actually use it — even though the SEC deems this systematic plan so safe that you can use it in your IRA retirement account.
Research firm Value Line even says this strategy is “ideal for retirement accounts such as IRAs, since [it] offer[s] income and protection.”
How much better would your retirement be if you could put away an extra 32% every year?
Institutional investors use this strategy all the time to lower their risk and improve their returns. But for some reason, individual investors almost never use it, even though it’s very simple, takes very little time, and is available to anyone who wants it.
Now, I’d like to ask you a question…
Let’s say you just bought 1,000 shares of Trina Solar (NASDAQ: TSL). Shares currently sell for $12.80, so you invested $12,800.
Now let’s suppose I told you I may buy your shares of Trina Solar at $14, only I need to wait until July 19 to decide. I will pay you an additional $700 to hold your Trina Solar shares until then.
The $700 is yours to keep, whether I end up buying your stock or not. And you could make an additional $1,200 on the stock itself. Your total take could be $1,900, or 14%.
And because you’ve already taken $700 in cash, you’ve lowered your risk on the stock.
So, would you do this? Would you be willing to lock in 10%-14% gains on every stock you bought just for agreeing to sell it at a higher price a month or two in the future?
If so, then you should consider using covered call options to boost your returns. You can easily make 32% more a year than you are now…
Covered Call Options: Safe and Profitable
Stock options get a bad rap. People say they are just for gambling, you will lose money if you buy them, and so on. And if you buy options as a wager on how a stock will move, yes, you may lose money if the stock doesn’t behave as you expect.
And let’s face it, stocks don’t always move as we expect.
What’s more, options are contracts that expire at a certain date in the future. It may be a few weeks or even a couple years, but option prices can steadily erode as they approach their expiration date. And most options expire worthless.
So this threat that you are likely to lose your investment if you buy options tends to scare people away.
Plus, there’s a fair amount of terminology unique to options that can be intimidating to individual investors.
And this is too bad, because they are missing a whole other way to use options to lower their market risk and generate steady profits.
Let me explain…
Have you ever thought about the people that sell options?
Like with any transaction, there is always a buyer and a seller. The buyer spends the money, and the seller receives it.
It’s the same with stock options: if you sell options, the buyer pays you, and cash is deposited into your account in a matter of minutes.
With options, you can make money by selling the right to buy stock you already own — at a higher price than what you paid! (When you sell a call option on stock you already own, it’s a “covered” call because the obligation implicit in the call option contract is “covered” by the stock you own.)
That doesn’t sound very risky, does it? But many individual investors can’t see past the risk of buying options, and so they miss out on this great source of income.
Assessing the Risks
When you buy a call option, you’re betting the stock will go higher. If it does, you will likely make money. But if the stock moves sideways, you will likely lose some money. If the stock goes down, you could lose a lot, or even all, of the money you put into the trade.
In other words, there’s only one out of three possible scenarios where you will make money. The other two end with you losing money.
Covered calls, however, are a whole different ball game when it comes to risk and reward.
For starters, when you sell a covered call, you keep that money. It’s yours no matter what happens to the stock.
If the stock rallies past the price at which you agreed to sell, you keep the money from the covered call plus the profit from the stock. If the stock moves sideways, you keep the covered call money and the stock. And you are free to sell another call, taking in more money.
If the stock moves down — which is always a risk in the stock market — you have the cash from the covered call sale to offset the stock price decline. Here again, though, you still have the stock and will be free to sell another call, take in more cash, and further offset any losses.
There are no limits to how many times you can do this.
There aren’t many win-win situations in the stock market. Covered call trading may be the closest thing to it.
Until next time,
Until next time,
A 21-year veteran of the newsletter business, Briton Ryle is the editor of The Wealth Advisory income stock newsletter, with a focus on top-quality dividend growth stocks and REITs. Briton also manages the Real Income Trader advisory service, where his readers take regular cash payouts using a low-risk covered call option strategy. He is also the managing editor of the Wealth Daily e-letter. To learn more about Briton, click here.