How You Can Make Big Funds Jealous

Amber Hestla's picture

Friday, January 6, 2017 - 12:00am

by Amber Hestla

There was an important news story in the latter half of December that seems to have been overlooked by many news sources. Bloomberg's headline was "Calpers Rings Pension Warning Bell." The response has been muted, but the truth is this story will affect millions of retirees and taxpayers around the country.

Bloomberg explained, "The chief investment officer of the $303 billion California Public Employees' Retirement System just recommended that it lower its annual assumed rate of return to 7% from 7.5%, which will require workers to contribute more money to the plan." That's bad news for most pensions.

This news presents a problem because many pension funds assume returns of 7.5% or more. Lowering the level of assumed returns means employees and taxpayers need to contribute more or benefits must be cut.

The pension problem will obviously affects taxes, public services, schools, and a number of other areas. But I want to focus on a less obvious question, which is what an individual investor should expect to earn from their investments. We all need to ask ourselves if we can really do better than Calpers, which has access to the best investment managers in the world.

I believe we can, and not just because I'm overconfident in our particular strategy. We have real, identifiable advantages over Calpers.

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Why You Can Beat Big Funds
Calpers is investing as a pension fund. Their job is to have money available to pay pensions when the pensions are due. As the population ages and pension payouts rise, Calpers needs to shift assets to fixed-income investments and even to cash in order to meet obligations. Given these constraints, the fund cannot deliver the type of returns an individual investor can achieve.

Individuals, however, are free to invest in anything they find attractive. They can also exploit niches that large investors are too big to squeeze into. Calpers managers could try to follow the strategies my Maximum Income subscribers and I use, which involve finding income opportunities with potential double-digit rates of return by using call options. But when they went to sell the options, they would move the market with their orders. Calpers is simply too big to use our strategies.

This is an advantage we have in the markets. Individuals cannot always beat large funds. For example, we cannot beat high-frequency trading firms at their game. But we can generate enough income to make Calpers jealous. Even better, we can use that income to lower our cost basis for our positions.

Cost basis is essentially what you pay to make a trade, like the total cost of a certain number of shares or options. What most investors don't realize, however, is that you can reduce your cost basis, effectively buying securities at a discount, with a simple strategy. This isn't some super-complex, risky derivatives trade that's inaccessible to everyday traders. It's an easy strategy that can be used by anyone to generate easy income with only a minimal amount of added risk.

I'm talking about selling covered calls.

How Covered Calls Work
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, known as the strike price, before a specified date.

When you sell (or write) a call option, you have the obligation to sell a particular stock at the strike price if it should rise above that price before the option expires. I only recommend selling covered calls, which means you own the stock you're selling calls on.

Essentially, covered calls allow you to get paid upfront to potentially sell a stock you own at a higher price sometime in the future. Whether the stock goes up or down, you can come out ahead.

Consider what happens when you sell a covered call:

For every option you sell, you receive income, known as a premium, upfront in exchange. This money is yours no matter what. It's deposited in your account just like a dividend. You can think of this premium as an effective discount on your shares. If you bought shares at $30 and the premium for a 100-share option works out to $125 ($1.25 per share), your cost basis for each share would then be only $28.75 ($30 - 1.25).

Once you sell a covered call, one of two things can happen -- either the underlying stock rises in price or it falls.

If it declines in price, your shares will decrease in value, but you have the option premium to counter the loss. In other words, if the shares fall, you're better off selling covered calls than simply holding the stock.

If shares stay below the strike price through expiration, the option expires worthless for the buyer. That's not necessarily a bad thing for sellers, though, because this means we keep the shares and have a chance to sell another call to capture another income payment. This is why you should only sell calls on high-quality stocks you would be happy to own for the long term.

But if the stock rises above the call's strike price, you will have to sell your shares to the option's owner. Anything between the price at which you originally bought the shares and what you sell them for is pure profit, in addition to the cash earned when you sold the option.

But Aren't Covered Calls Still Risky?
The only time you really give anything up with this strategy is if a stock's price soars past the strike price during the option's short life. In that case, you'll miss out on some capital gains. But for the high-quality stocks that you should be using for this type of trade (think blue-chips like Coca-Cola (NYSE: KO) or Intel (Nasdaq: INTC)), this type of surge is rarely a worry.

In any case, I think a tiny bit of added risk is an acceptable trade-off when you consider that my Maximum Income subscribers and I have been able to earn annualized gains ranging from 7% to 247%. Notice that my worst performance still matches Calpers' expectations for the year.

What this means is that there's no reason for you to take risky positions in the market this year. You can earn reliable, market-beating income by using covered calls. Even better, my research staff and I are here to guide you through the process, telling you which trades to make and when. If you'd like to learn more about this opportunity, I invite you to click here.

Amber Hestla does not personally hold positions in any securities mentioned in this article.
StreetAuthority LLC does not hold positions in any securities mentioned in this article.