Covered Calls Batch #1B

WHY DO COVERED CALLS WORK
We ended the last blog with thoughts on "Assets Producing Income." This is a solid way to get "cash flow wealthy." Think of the alternative: You trade your time for money. What about getting your money working harder for you? Getting your money to carry a bigger share of the load?  Many people do not know how to do this. Let me state it in a way that just might make sense to you.

We buy an asset, in this case a stock, and then sell a fluffy option against our position. When I say against our position I mean it's like a lien on a property. Someone has the right to buy our stock. Built into the option price is all the speculation and future growth possibilities.

Say, you buy a great piece of real estate. It's in a very desirable neighborhood, one that many think will grow in value. You not only rent it for more than normal, but what if you gave the renters the right to buy the property at a fixed price, say within a year or two. Question: Will people pay more in rent if they have the right to buy the property down the road? Will they pay more now to lock in the price? Understand this and you understand the power of writing covered calls.

The asset is the stock, you know exactly what you paid for it. There is no fluff. A stock price today is based on the anticipation of future earnings. Take that last sentence to the bank. However the option is loaded with speculation, along with the time to expiration. Think of Bank of America's stock at $7.05. It's solid right now, look at the investments of Warren Buffett. It is at $7.05 and the current book value is over $20. What a bargain. Now, what do investors think of the price and the direction it will move. The October call options are 55 cents to sell (Wednesday price). If you owned 1,000 shares, you could sell 1,000 of these options for $550. Yes, if you actually sold the stock you'd have to give back the 5 cents, or $50 (.05 X 1,000), but you take in $550 now. That's cash you can use. It's your money. The market gave it to you. Think of purchasing 1,000 shares for $7,050, or half of that on margin, $3,525. Now, by selling the option you take in $550 cash. Wow.

DOUBLE DIPPING.
From time to time in these blogs I mention the buy-back. I believe the buy-back is the most powerful strategy in the stock market. It's a wonder so few people know about it, and fewer yet use it. When you sold the option you opened a position on your stock. If you buy the same option now---same month, same strike price, same quantity---you would close the position.
Let's say the stock goes down to $6.95 and three weeks have elapsed. The option premium has gone down. Think how this works. You sold the fluff---including the time to expiration. Now the stock didn't move exactly like someone thought it would. The option is now going for 10 cents. After you check out the options for the next month out, and you like the new price, you decide to buy back the October's for 10 cents and sell the November's for 50 cents. You spend $100 to buy back, and take in another $500. What if you can do this every month? It's easier to do than you think. It's an awesome way to make repetitive income.
As I traveled the country, many students not only extolled the virtues of writing covered calls and how it "saved their fannies," but many told me how they were double- and triple-dipping. I set out the beat my own students at this process. Twice, once with Qualcom and once with Netflix, I was able to do five, read that 5, times in one month. I've tried since then and have not been able to do so. Twice, piece of cake. Thrice, tough but doable.
What you need to do this several times a month is three things:
      1)  An understanding of how the buy-back works.
      2)  Working knowledge of how to use orders and alerts to notify of stock movements and target prices.
      3)  A volatile stock, say one that moves 50 cents to $1 every few days. This is for stocks between $2 and $8.
           For more expensive stocks, the movement must be $2 to $5 every few days.
It's not that tough. It's even easier than you think. With internet access, a good broker, you are in the drivers seat.
The next blog will be about why we use cheaper stocks, instead of Google and Apple. We'll also continue with more inside secrets on how to excel at this process.