I would like to continue the educational process about using the stock market as a way to generate income. I firmly believe it makes a great part-time, home-based business. I will share a few covered call basics, then give a batch of stocks that generate around 10% cash this month, and even 20% if you use margin. At the end I'll give a few helpful hints and then make more useful techniques in Batch 1B.
Covered Call writing is a way to use an asset to sell a position against it for income. Rental real estate readily comes to mind. Or licensing something. You use an asset, keeping it intact to generate income. In the stock market, this works well because you are buying a fixed price asset, like a stock. At least it was fixed when you bought. Now you sell an option against your covered position.
Call Options usually give a person the right to buy a stock at a fixed price, called the strike price, on or before a certain date, called the expiration date. This type of investment has an added level of risk - that of the expiration date. Whenever an investment ends, say an option for six months to buy a piece of real estate, the clock is not your friend. Time works against you. Also, the option is very risky, so one should be very careful.
Let's look at the riskiness of the stock option. The option premium is made up of several components. One is the time to expiration. Another is a constant, built into the formula for pricing. But the fun begins with this third component, called the speculative value, or the implied volatility. We call all of these the time value.
Before we move on let me give one example of time value, or the speculative value. It is someone's guess, someone'e speculation. You could have an $18 stock with the $20 call option at 40 cents. Another company's stock price is also $18, but the option at $20 is $1.20. And our third stock at $18 has a $20 call going for $2.80. Why the difference? Aahh, there is the $64,000 question. Basically and simply, the 40 cent option says the stock is flat, it's not going anywhere. The $1.20 option says there is a slight amount of volatility. It's moving. The $2.80 says we have a mover. The option is expensive (the puts are probably expensive, too).
Expensive options do not necessarily make them better, or the stock better. A cheap option is not better or worse. The prices tell a story. Think of the process in reverse. Think like an option salesman, or think like a seller of the option. If you sell a call against stock you own, you are selling the right to let someone buy your stock at $20, in our example. If your stock is dead in the water, going nowhere, you're not going to get very much for selling the option. No one will pay you much. But if you have stock in a tremendous company, and the immediate future looks good, or there is good news everywhere, then the option is expensive. From your point of view, if you are giving up everything above $20, and that possible future looks good, don't you want to get paid well? That's why you get $2.80.
If we put real numbers to this trade, you would buy 1,000 (or any amount in lots of 100 shares), for $18,000, or $9,000 on margin. Now you sell the $20 call (ten contracts at 100 shares each) for $2.80, or $2,800. That's right, someone is willing to give you $2,800 cash now, and tie up your stock for the next four weeks. Now, as time moves forward, the stock will go up, down or sideways. If it's above $20 you will sell the stock, and keep the $2,800 and the new capital gains of $2,000. If it does not go above $20, you get to keep the stock and the $2,800. And you write the calls out for the next month, for say $2,900, or whatever you can.
HERE'S OUR SAMPLE BATCH #1A:
We'll take $20,000 and buy some stocks on margin, spending close to $40,000. We're looking for 5% to 10% option returns. This means our cash returns will be double this on margin.
FAS is going for $13.84, 1,000 shares cost us $13,840. We sell the $14 calls for October for $1.63, Or $1,630.
MU (Micron Technology---one of my favorites) is $6.98, or $6,980. We sell the $7 calls for 65 eents, or $650.
EK is $2.80, and we buy 1,000 shares for $5,600 and then sell the $3 call for 41 cents times 2,000, or $820
JDSU is going for $13.17, or $13,170. We then sell the $13 calls for $1.18, taking in $1,180.
We sold some of these in the money and some out of the money. I didn't do the calculations for the extra.
CONCLUSION
We invested $39,590 and took in $4,280. That's over 10% on the whole amount, but about 20% on our original $20,000.
And think of this: We have $4,280 in the account. We can pull it out and pay the bills. We could buy more stock with it. We could leave it there in the account to help with the margin. It's just cash in the account.
We did this with only one trade per stock. In real life we could do buy-backs and double dip. We can buy back and sell out the next month. We're in the game, putting time to work for us. We're in the game, selling the fluff of the options. We have assets producing income, helping us retire better.
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Copyright 2011 All Rights Reserved. Please see your own financial professional for trade suitability.
All prices and transactions are a snap-shot in time. Your results will vary.
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