Last week, I hosted a live training session with an investment newbie...
I love this type of one-on-one teaching. In our live demonstration, I showed her how to make her first option trade (she collected $210 instantly). I also explained the basics of my trading strategy and answered questions from readers like you.
I wish I could give everyone this one-on-one training, but I've done the next best thing...
I've put together a fantastic set of six videos showing you exactly how to use this strategy to "trade for income" in retirement. You can collect hundreds – or even thousands – of dollars... and it's safer than simply buying a stock. These videos are available to all my Retirement Trader subscribers on our website.
If you'd like to get access, click here for my live presentation.
If you've ever thought about making more income in retirement, I urge you to check out my Retirement Trader letter. Over the past eight years, we've racked up winning positions more than 94% of the time.
And until MIDNIGHT tonight, you'll get a full second year... for free. Click here for details. (This link does not go to a long video.)
Right now, I'm in Germany attending several conferences. But you've been flooding my inbox with options questions, so today I'd like to give you some answers...
Q: What happens if I already own an underlying stock and just want to generate additional income through selling a covered call? Do I have the choice of just selling the covered call without buying [shares] again? – S.V.
A: Absolutely, S.V.! This is one of my favorite ways to use a covered-call strategy... earning extra income on stocks you already own.
Let's say you own 100 shares of a company's stock. (Recall that 100 shares of stock equals one option contract.) You like the business, but you would be willing to sell your shares at a certain price...
With a call option, you can agree to hand over your 100 shares of the stock (called the "underlying"), by a particular day (called the "expiration date"), at a particular price (called the "strike price").
This is known as "selling" (and sometimes "writing") a call option... The call buyer pays you money (called the "premium") today in order to enter the contract. He agrees to buy the stock from you at that price, but it's his option to exercise or not. He is the buyer of the option, and you're considered the seller.
The risk here is that your shares are called away by option expiration day. But, if you're left holding shares, you can continue selling covered calls to boost your income.
Q: I've had success selling naked put options on similar stocks you propose in your covered-call strategy. Is this something you consider? – D.H.
A: Whether you sell a covered call, naked put, or a cash-secured put, the return of each trade is essentially the same, based on the amount of capital at risk (your potential obligation to put on the trade). It's just a different way to put on the same trade.
The biggest difference is that a naked put requires less cash up front. For puts, you have to put up "margin," usually about 20% of the money you would be obligated to pay if the option is exercised against you. A cash-secured put requires 100% of the money you would be obligated to pay. With a covered call, you buy shares first and then sell a call option.
When you see a difference in gains between naked puts and cash-secured puts and calls, this reflects the initial capital outlay. But remember... the put requires you to pay the other 80% if the stock is put to you. That's a real obligation... and when you factor that in, your gains are roughly the same.
Q: What about weekly options? – J.C.
A: Traditionally, options expire on the third Friday of the month. That's tomorrow this month and in April that will be the 20th. This is known as a "standard" option, and most (but not all) brokerage platforms will highlight in some way which expiration is standard.
However, as option markets have grown, investors have wanted more flexibility. Now you can trade options, known as "weeklys," on many stocks that expire throughout the month on Fridays.
In Retirement Trader, we stick to standard options as much as possible. If you don't see a date in our recommendation, we're always talking about the standard option.
We generally only branch into weekly options when they offer particularly compelling prices.
Longtime subscribers know that the best "time decay" in value of the options occurs between eight weeks and six weeks before expiration. So we make the most money per day from week seven to week five. That's why I like to sell options with about two months left to go... We ride right across that sweet spot of time decay.
Q: How do you use stop losses with covered calls? – N.F.
A: Stop losses are an essential part of my options-trading strategy. In Retirement Trader, I recommend that people set stop losses between 20% to 25%.
Let's take a look at an example... In this case, we'll use a 25% stop loss for a covered call.
Say you sold May $25 calls on stock XYZ. You had to buy shares of XYZ for $25 and, because you're selling calls, you collect a premium of $1. That means your total outlay – basically what you spend to open the trade – is $24 (the $25 stock price minus the $1 you received in call premium).
Remember, though, that you are buying 100 shares for every call option you sell against the stock. So the total cost of your trade is $2,400.
To figure out the stop limit, just take the combined value of the position and multiply it by 75%.
In this case, the combined value was $2,400 (cost of the shares minus the premium income)... $2,400 multiplied by 75% is $1,800. This gives you an $18 stop loss.
Now, because you'll have to buy the call back to close out the trade, you have to take that into your calculation.
Let's say that the option is trading for $0.25. You'd need to spend $0.25 to buy back the option. So you'd want to close the trade if shares hit $18.25 to account for that $0.25.
The most important thing to remember is to sell when you hit your stop.
What We're Reading...
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Here's to our health, wealth, and a great retirement,
Dr. David Eifrig and the Health & Wealth Bulletin Research Team
March 15, 2018