If you're like most investors, your portfolio is probably now sitting about where it was before the 2008 stock market crash. It was a long haul back, but many of you persevered.
So now that you have made it back, why not just put your money in something extremely conservative and be done with it? That might seem irrational, but I can’t tell you how many investors I know who are liquidating their portfolios. It’s lunacy, in my opinion.
There's a way that any self-directed investor can KEEP their stocks AND continue to make profits even if the market makes a turn for the worst.
The time has come for the average investor, whether wealthy or in the process of accumulating wealth, to consider using covered calls.
Covered calls are widely used by savvy "institutional investors"...pension funds, insurance companies, endowment funds and some mutual funds. The strategy is little known and often misunderstood by individual investors.
However, when using highly-liquid options on stocks or ETFs the combined return from potential capital appreciation and additional income you receive from covered calls can yield double-digit returns more predictably, consistently and conservatively than with stocks or ETFs alone.
As I have stated numerous times in the past, 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 more conservative than investing in stocks or ETFs alone and, most importantly, they can provide significant protection in a down market, and can be a key component for an investor to achieve double-digit returns in a flat or slow-growth market.
So I am certain that some of you are asking the question, "What is meant by the term 'covered' anyway?" (Click here to find out how to effectively use covered calls to enhance portfolio returns)
Simply stated, it means that you own shares of the underlying security, in our case a stock or ETF that stands behind the options. And you are selling calls against the "covered" portion that you own.
For example, let's say that you own 500 shares of Microsoft (MSFT) and you would like to increase your income on the MSFT shares that you own through the use of a covered-call options strategy.
Let’s say it is the third Friday in February (options expiration falls on the third Friday of each month) and you start to check into the premiums for MSFT options contracts with various strike prices and expiration dates.
While you like MSFT's long-term prospects, you think that the price of your 500 shares may not be higher than $3 above its current market price of $27 at the end of May expiration (100 days).
The front month March $30 call is trading at $.27 per contract. For receiving a premium of $.27 per contract you decide you would be willing to let go of your 500 shares of the MSFT at $30 if the price should be greater than $30 on the expiration date (in our case May 17).
So, from this transaction you will collect $135 in option income ($.27 premium per share * 10 contracts * 100 shares per contract). Annualized, the premium income at the current market price of MSFT will yield an additional 3.5 percent based upon that premium and the market price of MSFT. Not too shabby… particularly, when you consider that MSFT has a dividend yield of 3.3% . (In my Facebook example last week we learned how to tack on an additional 10-18% to our FB returns annually).
You also have the potential to realize an additional $1,500 of capital appreciation if the price of MSFT pushes up to the short strike of 30 by the May expiration date.
Now the downside.
If MSFT goes to, say, $32 before the expiration date, you would probably feel pretty bad that you had lost out on some additional capital appreciation. You would only receive $30 per share plus your option premium of $.27, or a total of $30.27 per share. In other words you would have missed out on receiving the $2 per share that your shares would have been worth had you done nothing but hold them. You also have $.27 per share of downside protection if MSFT's price heads south. So, it is still possible to lose money buying MSFT and using covered calls if the price of MSFT declines significantly. But, at least with covered calls you have some downside protection – which you wouldn’t have otherwise.
If you are caught in a declining market, you will ALWAYS be better off if you use covered calls on your shares instead of just owning MSFT.
If the market drops out and you aren't selling covered calls, then your shares are worth less, AND you're out the $135 (in our example) that you didn't collect from selling the calls.
Just remember, when using covered calls you are no longer in the business of trying to maximize capital appreciation on your shares. You are now in the business of using covered calls to provide a rate of return that will meet or exceed your objective on a consistent and predictable basis.
Given how this conservative strategy works, 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? This is why I decided to introduce this strategy to my Options Advantage subscribers.
You can learn more about how I safely use options for both income and to steadily grow my investment account by clicking here.
Editor and Chief Options Strategist
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