Most Popular
1. Banking Crisis is Stocks Bull Market Buying Opportunity - Nadeem_Walayat
2.The Crypto Signal for the Precious Metals Market - P_Radomski_CFA
3. One Possible Outcome to a New World Order - Raymond_Matison
4.Nvidia Blow Off Top - Flying High like the Phoenix too Close to the Sun - Nadeem_Walayat
5. Apple AAPL Stock Trend and Earnings Analysis - Nadeem_Walayat
6.AI, Stocks, and Gold Stocks – Connected After All - P_Radomski_CFA
7.Stock Market CHEAT SHEET - - Nadeem_Walayat
8.US Debt Ceiling Crisis Smoke and Mirrors Circus - Nadeem_Walayat
9.Silver Price May Explode - Avi_Gilburt
10.More US Banks Could Collapse -- A Lot More- EWI
Last 7 days
Stock Market Volatility (VIX) - 25th Mar 24
Stock Market Investor Sentiment - 25th Mar 24
The Federal Reserve Didn't Do Anything But It Had Plenty to Say - 25th Mar 24
Stock Market Breadth - 24th Mar 24
Stock Market Margin Debt Indicator - 24th Mar 24
It’s Easy to Scream Stocks Bubble! - 24th Mar 24
Stocks: What to Make of All This Insider Selling- 24th Mar 24
Money Supply Continues To Fall, Economy Worsens – Investors Don’t Care - 24th Mar 24
Get an Edge in the Crypto Market with Order Flow - 24th Mar 24
US Presidential Election Cycle and Recessions - 18th Mar 24
US Recession Already Happened in 2022! - 18th Mar 24
AI can now remember everything you say - 18th Mar 24
Bitcoin Crypto Mania 2024 - MicroStrategy MSTR Blow off Top! - 14th Mar 24
Bitcoin Gravy Train Trend Forecast 2024 - 11th Mar 24
Gold and the Long-Term Inflation Cycle - 11th Mar 24
Fed’s Next Intertest Rate Move might not align with popular consensus - 11th Mar 24
Two Reasons The Fed Manipulates Interest Rates - 11th Mar 24
US Dollar Trend 2024 - 9th Mar 2024
The Bond Trade and Interest Rates - 9th Mar 2024
Investors Don’t Believe the Gold Rally, Still Prefer General Stocks - 9th Mar 2024
Paper Gold Vs. Real Gold: It's Important to Know the Difference - 9th Mar 2024
Stocks: What This "Record Extreme" Indicator May Be Signaling - 9th Mar 2024
My 3 Favorite Trade Setups - Elliott Wave Course - 9th Mar 2024
Bitcoin Crypto Bubble Mania! - 4th Mar 2024
US Interest Rates - When WIll the Fed Pivot - 1st Mar 2024
S&P Stock Market Real Earnings Yield - 29th Feb 2024
US Unemployment is a Fake Statistic - 29th Feb 2024
U.S. financial market’s “Weimar phase” impact to your fiat and digital assets - 29th Feb 2024
What a Breakdown in Silver Mining Stocks! What an Opportunity! - 29th Feb 2024
Why AI will Soon become SA - Synthetic Intelligence - The Machine Learning Megatrend - 29th Feb 2024
Keep Calm and Carry on Buying Quantum AI Tech Stocks - 19th Feb 24

Market Oracle FREE Newsletter

How to Protect your Wealth by Investing in AI Tech Stocks

The Best Strategy for Dealing With the Stock Market Sell-Off

Stock-Markets / Stock Markets 2014 Oct 15, 2014 - 05:20 PM GMT

By: Investment_U

Stock-Markets

Marc Lichtenfeld writes:Investors have it tough today.

The market has been ugly the past few weeks, instilling fear in some investors that the bull market is over and they missed their chance at making money.

Additionally, interest rates are still so low, it's tough to generate any income from your nest egg.


However, the recent market slide is a perfect opportunity for investors who know how to pick up extra cash with a conservative strategy.

This method can easily generate a year or more worth of dividend income in just four to eight weeks. And the recent market volatility means we can actually make more today than we could have a few weeks ago on the same trades.

Let me repeat that because it's important.

The market sell-off means we can now generate more income than we could have just a few short weeks ago.

The strategy is selling covered calls.

Fear Not

Now, before you run away screaming because you've heard options are scary or complicated, understand that selling covered calls is more conservative than owning a stock outright. And it takes only one more simple step than simply owning a stock.

I'll walk you through the process right now.

Let's say you want to own shares of a blue chip dividend payer like <strong>Merck</strong> (NYSE: MRK). As I write this, to buy 100 shares, it would cost you $5,740. Shareholders receive an annual dividend of $1.76, or $0.44 per quarter. That comes out to a 3.1% annual yield. Not bad in today's low interest rate environment.

It's not bad, but 3.1% isn't a whole lot of income either. So an investor who wants to generate more income from his Merck shares can sell a covered call on the stock.

It's considered covered because the investor owns the stock already. If the investor sold the call without owning the stock, that would be a naked call. That's risky. Covered calls are not. I'll explain why in a moment.

The investor could sell a Merck December $60 call for $1.15. That means that he will collect $1.15 per share for 100 shares. Options are traded in 100-share blocks. So on 100 shares, the investor collects $115 cash immediately after selling the call.

Remember, we're <em>selling</em> calls, not buying them. The buyer of the call has the right, but not the obligation, to buy the Merck stock from the investor at $60. If at options expiration, which is typically the third Friday of the month, the stock is below $60, the call will expire worthless and the investor keeps the $115.

If the stock is above $60, the buyer will likely exercise the call, meaning he will buy the stock for $60. In that case, the investor must sell the stock for $60, no matter where it's trading. But because he bought it at $57.40, he'll still make a $2.60 per share profit or $260.

Additionally, he keeps the $115 he received for selling the call. And he also gets the $0.44 dividend if he owns the stock on the ex-dividend date.

So on a stock that yields 3.1% per year, the investor who sells a covered call earned 7.3% in two months. He earned more than twice the income in one-sixth the amount of time.

Even if the stock price falls below where the investor bought it, he still collects the $0.44 per share dividend like normal and keeps the $115 option premium he received for selling the call.

Because of that $115 or $1.15 per share, the breakeven point is now $56.25 instead of the original price of $57.40. The option acts as a buffer against falling prices and is the reason covered calls are more conservative than owning a stock outright. When things go bad, you lose less.

Be the House

When you go to a casino, you know you may get lucky, but the house usually wins. When you sell a covered call, you are the house. You're selling a call to speculators who are betting on the stock price going up. More than 80% of options expire worthless, which is fine with us because we sold it already; we didn't buy the call and own it. We own only the stock.

Right now is a great time to sell covered calls because market volatility has increased significantly. There are several components that go into how options are priced. I won't bore you with the details here (if you want more information, click here, but when markets get more volatile, option prices get more expensive.

So with the current market environment rather volatile, those options have become more expensive, which is good news for option sellers. They get more money for the options they're selling than they would have a few weeks ago.

You can see that selling covered calls makes a lot of sense in the current market - especially with all of this volatility. Low interest rates and yields combined with higher volatility means that covered call sellers can make more money with less risk than they could by just owning a stock.

Good investing,

Marc

Source: http://www.investmentu.com/article/detail/40430/covered-calls-best-strategy-for-dealing-with-market-sell-off#.VD7IY010y0k

http://www.investmentu.com

Copyright © 1999 - 2014 by The Oxford Club, L.L.C All Rights Reserved. Protected by copyright laws of the United States and international treaties. Any reproduction, copying, or redistribution (electronic or otherwise, including on the world wide web), of content from this website, in whole or in part, is strictly prohibited without the express written permission of Investment U, Attn: Member Services , 105 West Monument Street, Baltimore, MD 21201 Email: CustomerService@InvestmentU.com

Disclaimer: Investment U Disclaimer: Nothing published by Investment U should be considered personalized investment advice. Although our employees may answer your general customer service questions, they are not licensed under securities laws to address your particular investment situation. No communication by our employees to you should be deemed as personalized investment advice. We expressly forbid our writers from having a financial interest in any security recommended to our readers. All of our employees and agents must wait 24 hours after on-line publication or 72 hours after the mailing of printed-only publication prior to following an initial recommendation. Any investments recommended by Investment U should be made only after consulting with your investment advisor and only after reviewing the prospectus or financial statements of the company.

Investment U Archive

© 2005-2022 http://www.MarketOracle.co.uk - The Market Oracle is a FREE Daily Financial Markets Analysis & Forecasting online publication.


Post Comment

Only logged in users are allowed to post comments. Register/ Log in