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Answering Your Questions

By: Wyatt Investment Research
Posted: 10/29/2013 10:18:00 AM
Referenced Stocks: ITM

Last week, more than 300 people tuned in for my exclusive webinar. During this one hour investing seminar, I share my single best strategy for earning extra income.

The unfortunate thing is that most individual investors - including those with lots of experience - overlook this unique strategy. That is why I arranged for this opportunity to show Income & Prosperity readers how to earn extra income by using covered calls on blue chip stocks.

If you were unable to join me for the webinar last week, I encourage you to watch a rebroadcast right now. Just click here: Covered Calls 101 - With MSFT and INTC

I believe every income investor should be using covered calls to earn 2x - 3x the investment income from blue chip stocks.  If you're like most of my readers, you may think that covered calls are either boring or complicated.  My goal is to prove to you that this strategy could mean all the difference.

But I know that your time is valuable, and you may now be able to spend one hour watching my presentation.  So what I'm going to do today is answer some of the most common questions that might help you understand this opportunity.

I recently retired, and I'm a conservative investor. Do you think covered calls are an appropriate strategy for someone like me?

Covered calls are the only option strategy available to use in retirement accounts. I think that alone speaks volumes as to how inherently conservative covered calls are as an investment strategy. I tell investors all the time, particularly retirees that there is no better way to consistently bring in income on a residual basis. Moreover, the strategy actually decreases volatility within a portfolio. It's a win-win for all investors, especially those who seek reliable, consistent income.

I would love to earn an 8 - 10% yield from my blue chip stocks.  Is this really possible?

Yes! We started High Yield Trader as a way to help our readers earn more income. At minimum, our goal is to double the dividend in every shareholder-friendly, blue-chip company we add to the portfolio. Since the service started roughly six months ago, we've been able to double, triple, even quintuple the dividends on half of the holdings within the portfolio. So yes, it is possible. And most important, is that it's possible without taking huge risks.

How do I know which strike price to use for selling covered calls?

This is probably the most frequently asked question among investors new to covered calls. That's understandable because there is a huge range of choices available in an options chain. For someone new to covered calls it can be overwhelming.

Below is the options chain for Microsoft (Nasdaq: MSFT) , one the stocks we discussed in the webinar and one of our High Yield Trader holdings.

As I'm writing this, MSFT is trading for $35.30.

So basically, the further out of the money the call options sold, the more room there is for the stock to go upwards, but the lower the premium received from the call options themselves.

Let me explain using the options chain below.

Right away, you will notice difference in color between the in-the-money ( ITM ) and out-of-the-money (OTM) options. Beige is ITM and white is OTM.

Basically, the closer you sell an option to the at-the-money strike -- in our case the 35 calls are considered at-the-money -- the less room there is for the stock to go upwards but the higher the premium received from the call options themselves.

The reason is because there is a greater chance for stock to close above the strike at expiration. Obviously, the further away we are able to sell our call strike the more margin for error and the greater the chance of success on the call sold.

Yes, there is no free lunch in options trading and options trading is all about trade-offs between profitability and risk. As such, your outlook on the performance of the stock is pivotal in deciding which strike price works best. If you expect the stock to go up significantly, you would write further out-of-the-money call options, while if you expect the stock to still go up only very slightly or not at all, you might decide to write just slightly out-of-the-money call options or even at-the-money call options. A popular method used in options trading is to sell the call options on the price at which you expect the stock to peak.

Within High Yield Trader we take the guessing out of the equation by selecting probabilities calls that are higher than 70% (as seen in the far left column). By using probabilities, we would sell the December 37 calls (77.23%) or the December 38 calls (86.77%).

Also, you have to consider transaction costs on the options you wish to sell. If they're only worth a nickel or a dime, they are probably not worth selling because of the transaction costs, so you have to go out longer in those cases to get enough premium to cover your transaction costs.

Which expiration cycle do I use to sell covered calls?

Unless you have a strong reason to do otherwise, the practice in options trading for covered calls is to sell the calls 1-2 months out as they expire fastest, putting time decay in your favor. Remember, we are selling our calls to speculators so the best-case scenario is to have our calls expire worthless. This means that will receive the max profit on the trade.

Again, I hope you have a chance to watch our latest webinar. It's a great primer to get you started using covered calls on some of the most shareholder-friendly, blue-chip companies available to investors. In fact, MSFT and INTC are two of our favorite candidates.

As always, if you have any further questions please do not hesitate to email me at editor@incomeandprosperity.com