Writing Covered Call Options To Boost Returns On Stocks
The Dynamic Wealth Report
June 4, 2008
Doubling My Return In 2 Months On A "Boring" Stock
You read the title right. Over the last two months I doubled the return
on one of my investments. This isn’t in theory. This is an actual trade
I made in my retirement account. It’s easy to do, and you can do it to.
Regular readers know that every once in a while I write about trades
that I make. Today’s one of those days. I’m going to let you look into
my personal investments, something usually only viewed by my tax guy and
lawyers.
But before I go any further a word of caution.
My trading limits might be significantly different from yours. You and I
might have very different financial situations, risk profiles, and
experience levels. So don’t just blindly copy what I do. Before you make
any investment, make sure you know your limitations and risk tolerances. And most importantly, make sure you understand what you’re doing. It’s
your money and nobody will care for it more than you.
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Ok, onto the trade.
Now, I know what you’re thinking. How did he double the return on an
investment in only 2 months? The answer is simple. I know a “secret”
trading technique that puts money in your pocket every time you use it.
And it’s easy to do.
As I mentioned before, I did all this in my IRA. My IRA is where I hold
my long term investments. The securities I buy in this account I plan to
hold for a very long time. As Warren Buffett famously quipped, “Our
favorite holding period is forever.” I feel the same way.
I’m not going to bore you with a list of everything I hold.
What I will do is share with you a technique used by a great many
institutional money managers and serious investors. It basically adds
cash to your account almost every month. Not many people do this. But
almost anyone can.
Here’s the trade.
Back in April I started doing research on the REIT market. In my
research I uncovered a number of interesting data points. I liked
the trade so much I wrote an article about it: “My Latest Trade . . . .” If you haven’t read it or don’t
remember it, take a quick look at it now.
So, what did I buy?
I bought the iShares Dow Jones U.S. Real Estate Index Fund (IYR). This
ETF holds a selection of some of the best REITs in the market including:
Annaly Capital (NLY), ProLogis (PLD), Simon Property Group (SPG), and
Vornado Realty Trust (VNO).
The ETF is well diversified and it pays a nice dividend. I also noticed
the price had fallen from a high of over $95 to the low $60s. I bought
IYR for my IRA around $66.50.
Now I’m perfectly happy sitting on this investment. I expect in 10 or 20
years it will be significantly higher in value. As I write this, about
two months later, IYR is trading around $68.25. This gives me a return
of 1.75%. Not bad for a few months, but nothing to get excited about.
But I wasn’t done.
Here’s the secret to improving your returns. IYR is a nice long term
investment, but it’s not very volatile. That makes it a great security
to write covered calls on.
If you don’t know, “writing covered calls” is a basic options strategy. You sell a “call option” against a security you already own. When you
sell that option, you take on the obligation to sell your security to
another investor at the “strike price.” In exchange they pay you a
“premium.” Cold hard cash, up front.
So this is what I did.
First I bought 100 shares of IYR at $66.50. Then I sold one call option
on IYR. The “strike price” was $73 and the “premium” was $1.55.
This meant that I agreed to sell my shares of IYR to the investor who
bought my option at $73. I’m obligated to do this. If IYR rockets to
$100 I’d still have to sell at $73. For taking on this risk I got to
collect an immediate payment of $1.55 per share.
Remember, there’s 100 shares in every options contract . . . it makes
the math really easy. So I got paid $155 for selling this option.
One more detail.
The option I sold was a June option. This means that the investor who
bought my option has until the third Friday in June to exercise the
option. If he doesn’t exercise the option by then, I get to keep
my IYR shares and his
money. Might this option get exercised? Maybe, but I don’t think it
will. There’s only 12 trading days left.
Now I know what you’re thinking. $155 doesn’t seem like much. But do the
math. It works out to a return of 2.3%. So while my IYR shares are up
about 1.75%, my option trade added 2.3% on top of that . . . That’s how
I doubled my return in 2 months!
Here’s the truly amazing part, I sold an option that was about 2 months
out. That means I can do this same trade 6 times a year. A little back
of the envelope math and you’ll realize that I can make an extra $933
every year (6 x $155 = $933).
That’s an extra 14% per year for just a few moments of my time. And, I
still get the dividend (which would add another 4.5%). Now we’re looking
at an 18%+ return even if the stock doesn’t move. That’s more like it!
Now keep in mind, I didn’t include transaction costs or taxes to keep
this example simple. . . you’ll need to pay both.
So here’s a question for you.
Have you ever made a trade like this? Do you have experience with
covered calls? Do you have a story about making money with covered
calls?
If so, write to us:
customerservice@hyperionfinancial.com. We’d love to
hear your experiences trading covered calls. Who knows, you might find
your story mentioned in a future issue of the Dynamic Wealth Report.
• Soybeans ($13.50 per bushel)
Soybeans and a number of other commodities have fallen over the last few
days. The Commodity Futures Trading Commission (CFTC) announced plans to
examine price volatility in the markets. One of their announced targets
is adjusting speculative limits. I’d expect commodities to trade lower
on this news for some time.
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