Entering the new presidency we will begin to see uncertainty as the markets gear for some major transitions. With this uncertainty opens up a new investing strategy. One of the more underused strategies is selling covered calls. Selling covered calls is a way to earn extra return on stocks that you are long on. By selecting the correct future prices you can not only earn a decent return on your investment if it reaches the strike price but also on the extra money from selling the original call. As we transition into the New Year we will see the market begin to move sideways as investors take to the sidelines to weigh in on future moves by the Fed and other government banks. Also with tensions high between the United States and Russia we will begin to see more and more wait on the sidelines to see the effect of each move. There are several ways to make money during these durations. One of the more easier ones is covered calls.
I will be discussing on using covered calls for your advantage with stocks held long. More likely than not long investors spend a lot of their time wanting to see their portfolio shoot up overnight. Selling covered calls is a very valuable and underused tool by long investors. By selling covered calls you are able to make extra returns on stocks that you are long on. This is also another option that allows you to continue to make money without worrying about constantly trading a company that is behaving cyclical at the current time. There are several ways investors can use covered calls.
The first option is a very passive approach. It is great for young investors. If company XYZ is selling at $8 new investors can look for calls selling out-of-the money. As investors know the premium for out-of-the money calls is due to value of time. If the next month call at $10 strike price is selling at $.50 this is a very lucrative call to sell. Selling at $.50 call at a strike price of $10 gives you a $2 gain per share if the stock reaches $10 and the call is utilized. Not only does this give you that gain but you will make an additional $50 profit. This $50 profit alone is a 6.25% return on your investment not including the percent gain from the increase to $10. If the call does not reach $10 then you at the minimum have made a 6.25% return on your long-investment. If the call is utilized this cover call gives you some room to invest back into XYZ company without losing the number of shares you hold. We will call this the buffer zone provided by covered call. The $.50 proceeds from the covered call is your buffer zone. If you have a $12 valuation of this company and remain bullish after the call is utilized then you are able to buy back your number of shares at a breakeven price of$ 10.50. Because of the money you made from the covered call you are able to buy back your exact shares if not more shares for any price under $10.50. Of course this buy back price will vary due to varying commission prices at different brokerages. For the inexperience investor letting the option expire will be the easiest option. If the option expires out of the money you keep the $50 for the value of time and are able to continue to look for other calls that offer a high premium on the value of time. If the option expires in the money then you have the buffer of $10.50 to buy back your shares.
This option is a more active approach. Instead of letting the option expire worthless you buy back your covered call. In this option you buy back your call. For example following the previous option if the company that you are long on is well below the money and the value of time begins to decay rapidly then it may be time to buy back the covered call. If the price of the call drops to $.10 you then buy back the call and keep the $40 gain or 5% return. When you sell this covered call it is then time to look to an option further in the future. You can then sell a covered call for further in the future where there is a higher premium on the value of time. This is a more active approach because as you approach the expiration date the value of time begins to decay more rapidly. This active approach can earn you more money because you do not have to wait for the option to expire out of the money while other opportunities pass by.
This option can be used for companies that make rapid climbs over a short period. In this option if a XYZ price increases rapidly before you are able to enter the market you are still not out of look to enter in. Often as a company increases rapidly the next couple days or weeks you will see the price decrease or remain trading the same as investors begin to take profit. The goal here is to buy on a increase and quickly sell a covered call that has rapidly increased with the price. Buy selling a covered call here you are able to secure a lower cost basis. If company XYZ shoots up to $9 you can quickly buy your shares and then sell a covered call. By now the $10 call for example may be selling at $.75. If you are able to sell this call then you can lower your cost basis. If the price decreases you have a $8.25 buy in price. You have this cost basis because of the profit made from the call you sold. If the call expires out of the money you are able to sell XYZ above $8.25 and make a positive return. If the option expires out of the money you are able to sell at $8.25 and break even because of the $75 you made from the covered call. If for example the price drops to $8.50 you can then sell and make $850 from the company and S75 from the covered call for a return of $925 from your original investment of 900. This is a $25 gain or a 3% gain.
Selling covered calls is a underutilized tool for long investors. Selling these covered calls is a way to make extra returns on top of the gains from the increase in price from the company. As the market begins to move sideways following the Trump Rally, this is a tool to continue to make extra returns that you can then use to reinvest in your portfolio