Chasing the Bull

Many investors are interested in selling covered calls but really do not know how to begin. This is actually my favorite investing strategy, and as such, I will be allocating a great number of posts to this topic.

Introduction
An option is a financial instrument representing a real contract. It gives the holder the right, but not the obligation, to buy or sell the underlying asset at a certain price up to a certain date (expiration date). Until the expiration date, the holder has the right to buy or sell the underlying stock if the transaction is to his or her benefit. After the expiration date, your option is worthless.

Buying and selling calls and puts is an extremely risky form of investing. These speculators risk their entire investment on a guess of which direction their stocks are heading. Myself, I prefer to sell covered calls which generates consistent monthly income for my portfolio.

The covered call technique involves utilizing “call” options only. Options trade on the stock market just like stocks do. This fact allows us to generate monthly income by selling calls to speculators. Let’s look at a quick example:

Crocs, Inc (CROX)
Current Price - $17.18
Near Month Option - April 2008
Closest Strike Price - $17.50 premium of $1.30

For this example, you would buy 100 shares of CROX at $17.18 and immediately sell 1 April ‘08 $17.50 call for $1.30. My broker, thinkorswim, gives you the ability to do both at the same time. I like this feature because I am only charged one commission of $5, instead of 2 if I did them separately.

The 100 shares would cost you $1,723, but this would be offset slightly by the $130 of income you received from selling the call. Now all you have to do is sit back and wait until the third Friday of April (the expiration date). In this simplistic example, two possible outcomes exist:

1. The stock closes below $17.50 on expiration date and you are not called out. For this transaction, you “earned” a one month return of 7.5%. You earned this money by selling the call to the speculator (who lost all of his money). You now have 100 shares of CROX with no open calls against it. You are free to sell another call or sell the stock.
2. The stock closes above $17.50. In this case, you will get called out of your stock. Don’t worry, it happens automatically and there is nothing you need to do further to make it happen. For this transaction, you earned a one month return of 9.1% [((17.50-17.23)+1.30)/17.23]. Not a bad one month return if you ask me.

Like I said above, this is my favorite investing strategy. It is a powerful way to increase your wealth because you are continually generating cash flow from your stock investments, while simultaneously lowering your cost basis in the stock. It does, however, have its drawbacks. As this post was meant to be an introduction to selling covered calls, I will create a future post describing the challenges of this technique.

Are you selling covered calls? Have you ever wanted to try it? I would love to hear of your experiences selling covered calls.

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It is Thursday afternoon. Do you know what your employees are doing?

If they are anything like me, they are trying to get onto CBS Sportsline to watch the opening round of the NCAA tournament. Currently, I am number 64,500 in line.

I have read all the articles about the amount of money wasted by employers whose employees are watching the games instead of completing their work. As the boss, I wish someone in my office actually wanted to watch it with me. Unfortunately, I guess I am the only one who cares anything about it. Thus I sit here wasting time on my own, waiting to move up in line, seemingly one spot at a time.

As I have been sitting here, I began to think of all of the guys and girls out there like me, who are truly surfing the net, wasting time until our turns. Is there a way that I could have made a few dollars while I wait? I guess this time is similar to the time we have sleeping. If you only make money from tasks that you actually participate in, time becomes your limiting factor. Afterall, time is probably your most important asset.

Over the course of the next few weeks, I am going to try and explore various ways of increasing my passive income. I need a source of income that continues to work while I sleep, spend time with my family, wait in a virtual line to watch a game, etc. Until then, the NCAA tourney will keep me occupied. If I could ever move up in line, that is!

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