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The Trade Most Investors Are Afraid to Make

Written by Briton Ryle
Posted April 12, 2017

Have you ever traded a stock option? I'm gonna go out on a limb here and say probably no. After all, it's hard enough for many people to just buy a stock...

Seriously — I see it all the time. I'm the editor for an investment newsletter called The Wealth Advisory. I specialize in finding great companies that pay you to own their stock. It's the purest form of capitalism, exactly what it was meant to be: as an owner, you get to share in the success of the company.

And I don't mean you get to go to rah-rah feel-good meetings. I mean when you own a share of these companies' stock, you get paid a share of the profits every three months.

Honestly, it's a beautiful thing. Any American can hitch their wagon to a company they like. You don't have to ask permission. There's no job interview. There's nothing at all to stop you from being a minority owner of Starbucks. Or Bank of America. Or Disney. And once you're an owner, these companies will send you your cut four times a year.

Or if you want, you might choose to get more stock instead of the cash dividend and grow your ownership stake over time. Ownership is the easiest way to make yourself wealthy in America today. It's a formula. It's not luck or some kind of business savvy. You don't even have to work hard to achieve this American Dream. All you need is a simple plan...

With some pretty basic assumptions, I can show you the type of wealth that can easily be yours. Let's start with finding a great company (I'm going to use Starbucks in this example). How do you find one? Well, here are two questions to get you started. The first question to ask about a great company: Will it be around in 20 years? With Starbucks, I think it's a pretty good bet. 

The second: Can the company raise prices 10% and not lose customers? For businesses like McDonald's or maybe even Netflix, the service is a value proposition. I think customers ask themselves, "Is this worth it?" But with Starbucks, there's an experiential aspect — a "cool factor" that you can't really put a dollar sign on. I bet no one bats an eye at a 10% price increase. 

Now, once you've found a great stock, let's have a look at what it can do for you...

A Simple Plan for Wealth

The basic assumption I will make about Starbucks is that the stock price and the dividend will each grow 10% a year.

I first recommended Starbucks to my Wealth Advisory subscribers in 2012 at a split-adjusted $22.85. The stock is at about $58 today. That's way better than 10% a year. And the dividend has been growing around 25% a year since the company started paying out in 2010. 

When you make a simple plan, keep it simple. I could use bigger numbers for Starbucks' growth. That would sure make this next part look more impressive. And great companies tend to outperform. But there's no need to paint the rosiest picture possible because this simple plan is powerful.

And besides that, things don't go in a straight line. There will be a recession, or Starbucks' China growth will hit a speed bump... stuff happens. 

If you buy $1,000 of Starbucks stock today, and if you can then put an additional $100 in a month, and if you reinvest all dividends, in 10 years, your stake is worth a little over $31,000. In 20 years, it's worth $141,000. But here's where it gets really good: After 25 years, your stake is worth $416,472, plus a dividend check for over $29,000 in cash. 

This is like the greatest savings account there ever was. Because it compounds your money at an exponential rate. And if you use a Roth IRA retirement savings account, you will pay exactly ZERO taxes when you start cashing your fortune out. The Roth IRA is the single-greatest gift the U.S. government ever gave retirement savers. 

Now, I'm about to turn 52. So I'm quite aware that 20 or 25 years might be asking a lot. But I've got two kids who will benefit greatly from a modest investment plan. Maybe I'll be fortunate enough to have grandkids one day. My simple plan might help them live a worry-free life, too. Maybe that frees them up to put my great-grandkids through college with no debt. 

Not With a 10-Foot Pole

Now, like I said earlier, I am the editor of a dividend and income newsletter called The Wealth Advisory. I have laid out the case for a powerful long-term investment plan to my readers many, many times. But still, roughly 30% of my subscribers have never bought a stock! 

That's right: a few thousand people are paying $49 a year to get my investment newsletter, and they aren't buying stock. Now, please understand, I'm not making fun here. I totally understand that embarking on a 20-year plan is not an easy thing to do. And I hold out hope that as they continue to see how the great stocks in The Wealth Advisory portfolio perform, and as they get comfortable with my analysis and strategy, they will make the life-changing leap. 

So, given the difficulty so many people have with buying stocks, I'm not at all surprised that most people's eyes glaze over when I bring up stock options. Stock options have the reputation of being risky, esoteric assets that have nothing to do with the real world — people reflexively say, "No way, I'm not touching options, not with a 10-foot pole."

But the thing is, options were risky, esoteric assets 20 years ago. A lot has changed in that time. 

These days, around 16 million options contracts get traded every day. That's equivalent to about 10–15% of the daily volume on the S&P 500. In other words, stock options are significant. And I can show you how with a simple example.

A "call option" is a contract that gives you the right to buy stock at a certain price. You are literally "calling" the stock to you. Today, call options are used to buy stock without moving the market price of a stock. Say you run a mutual fund and you want to buy a million shares of Bank of America. You can put in a buy order for those shares. But when you do, a lot of people can see that order. High-frequency traders can jump in ahead of the order and push the price higher, forcing you to pay more. That's a situation that is perfect for call options...

Call options trade on a different exchange. So people can't front-run your trade. But if you watch the volume on options for particular stocks, you can get great insight into what the big players are buying. 

I did this two weeks ago on an oil stock called Oasis Petroleum (NYSE: OAS). Now, two weeks ago, sentiment on oil prices was bad. U.S. shale production growth was eating up OPEC's production cuts. Oil prices had fallen from $55 to around $47. But then I saw some huge call options bought for Oasis. Why would anyone want to buy Oasis stock when oil was doing so badly?

Well, I didn't think about it too much. I told a group of my readers to jump on board. Two days later, Oasis stock was up nearly 10%, and the value of those options had doubled. And look at oil today. It's back above $53. Saudi Arabia is talking about more production cuts. And U.S. military strikes in Syria have upped tensions in the Middle East, which is always bullish for oil prices. 

Did some big money have advanced intel about the Syria action? Did somebody know that Saudi Arabia was going to push for more production cuts? Yeah, probably. And they tipped their hand by buying call options.

This is one example of how you can get an edge on the market. So before you say you wouldn't touch options with a 10-foot pole, consider that a little understanding can go a long way toward making you some loot.

Until next time,

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Briton Ryle

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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.

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