Most people think investing success is a matter of finding good stocks and buying them when the odds favor a rise in the price.
They buy a blue-chip stock like Procter & Gamble (NYSE: PG), Amazon.com (Nasdaq: AMZN), Philip Morris (NYSE: PM) or MasterCard (NYSE: MA), monitor their position closely, collect any dividends that may come in -- and hope things work out.
While most investors have studied different methods of analyzing what stocks to buy and when, few have considered all of the possible trading tools at their disposal.
As for me, I'm not interested in simply buying good stocks, waiting for dividend checks to come in, and hoping for the best.
Instead, I'm interested in earning income. Now.
That may sound a little impatient, but I assure you it's not. In fact, some of the world's best money managers and hedge funds have the same goal.
One way we can achieve this is with options.
Most individual traders would probably say that options are among the riskiest investments anyone could make. They're partially right -- trading options the way most individuals do is risky. But options have been used for decades by Wall Street firms to manage risk.
Today, I want to show you how to use options the way a Wall Street firm would -- as a valuable risk management and income-generating tool -- rather than the speculative way most individuals trade them.
If you've read my articles on using options for income, you know that, according to the Chicago Mercantile Exchange, options tend to expire worthless about 82.7% of the time. That's bad news for buyers, who lose their entire investment when this happens, but it means that 82.7% of options trades were profitable for sellers.
Readers of my Maximum Income newsletter are very familiar with this statistic, and they're using it to their advantage by being on the winning side of this trade -- they're sellers. Specifically, we do this by selling covered calls.
Let me explain...
A call option gives the buyer the right -- but not the obligation -- to buy a stock from the call seller if it's trading above a specified price (the "strike price") before a specified date (the "expiration date").
The expiration date defines the last day a buyer can exercise the option. Expiration dates can range from just a few days away to as far out as a few years. My Maximum Income readers usually use options with expiration dates within the next three months.
Sellers have an obligation to fulfill the other side of the trade if the buyer exercises the option. If you sell a call option, you will have to deliver the stock to the call buyer if the price rises above the option's strike price. (It doesn't make sense for the buyer to exercise his option to buy the stock if he could buy it below the strike price on the market.)
As a rule of thumb, I always recommend selling covered calls -- call options on stocks that you already own -- with strike prices above the stock's current price. Whenever you sell a call, you generate a premium, or what we call "instant yields," upfront as pure profit.
In addition to the cash premium, any upside the stock experiences from when you buy it to when you sell it at the strike price is yours to keep. With this strategy, you get paid cash for the opportunity to sell your stock at a profit.
If the shares stay below the strike price, then the options you sold expire worthless. That's a good thing when you sell covered calls, because it means you keep the shares and can sell more calls on them in the future. Since my strategy involves selling options that expire every few months, you can sell covered calls on stocks that you own several times a year, which means you could triple or quadruple the income you receive.
We can use this, along with our knowledge that most options expire worthless anyway, to create a high-income strategy -- the same kind used by countless successful Wall Street hedge funds and money managers.
You can even begin using this strategy on stocks you already own -- and more than likely, with the broker you already use.
Once you begin using this strategy, it's easy to see the possibilities. For example, let's take a look at the blue-chip stocks I mentioned above to see how much income you could be collecting from them today.
To give you a better idea of the power of covered calls, I want to tell you about a covered call trade for MasterCard that I recently shared with readers.
When I alerted readers to this trade, MA was trading near $76.50, so buying 100 shares would cost around $7,650. Once you own shares, you are eligible to sell covered calls on them.
I recommended selling the MA March $78 calls (a call option that expires in March and has a strike price of $78) for around $1.70. Each contract you sell controls 100 shares, so readers who took this trade immediately collected $170. This number can be easily scaled up; if you owned 500 shares of MA, you could sell five covered call contracts, which would rake in $850 in income instantly.
This money is yours to keep, no matter what.
Selling this call means you will have to sell the stock at $78 if shares trade above that on March 21 (the last day these options can be traded).
If MA is trading for less than $78 on March 21, readers will keep the $170 premium and their shares, for a total return of 2.2% ($170 gain/$7,650 investment) in the 43 days between the recommendation and the option's expiration.
If you repeated this trade every 43 days for a year, you'd earn about $1,443 without selling a single share of stock. To get that amount from dividends alone, MA shares would have to pay an 18.9% yield.
All this from a blue-chip stock that currently yields less than 1%.
Now, if MasterCard trades above $78 on March 21, the stock will be called. In that case, readers will sell the shares to the option buyer for $78. But that's still not a bad thing. By selling the covered calls for $170 per share, you lowered the cost basis of the investment to $7,480 ($7,650 - $170 premium). So when you sell the shares for $7,800, you've earned $320 in capital gains for every 100 shares. That's a 4.3% gain in 43 days, or a 36.3% annualized return.
Action to Take --> This is just one example of how you can use this option strategy to generate income streams worth thousands of dollars a month. As you can see, selling covered calls is the closest thing to a no-lose situation in the financial markets. You can use it as a stock selling strategy to ensure that you sell when stocks hit their target price. Best of all, it puts you in command of how much income you receive from your holdings, even if the stocks don't pay a regular dividend.
This article was originally published at ProfitableTrading.com:
The 18.9% MasterCard Yield Most Investors Overlook