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 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
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
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 (Nasdaq: MSFT)
and you would like to increase your income on the MSFT
shares that you own through the use of a covered-call options
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
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
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
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
You can learn more about how I safely use options for both
income and to steadily grow my investment account by
Editor and Chief Options Strategist