Many of our members manage their portfolios actively. This is the first of a series of active investing posts in order to give them some insights. If you have not read the Caveat entry below, please do so now.
Last Monday, July 20, we wrote just out-of-the-money covered calls on Coca-Cola (symbol KO), expiry date, Friday, July 24, (KO C 24JUL20 46.50) and received 1.5% return for the five days!
At expiry time, KO closed above our strike price and we were assigned. Our KO shares were taken away from us at the strike price ($46.50 US) and we were in cash. What to do with the money?
To continue our involvement with derivatives, we could write cash-secured puts on any security. Just in-the-money strike price written on Monday, July 27, expiry date Friday, July 31, gives the best premium returns on cash-secured puts. For KO, P 31JUL20 48.50 closed on Friday, July 24 at a premium of $0.36.
That works out to .36/48.50 x 100 = .74% for the week. That is not nearly as interesting as it was last week, so let us look at other possibilities.
Novavax (symbol NVAX) is an example. It closed at $133.00 US on Friday, July 24. Selling cash-covered puts, strike price $130.00 US, expiry date Friday, July 31, (NVAX P 31JUL20 130.00) gave option sellers $7.00 US per share last Friday.
That works out to 7.00/130 x 100 = 5.3% for the week!! It gave some protection from having the security put to the investor.
To lower the possibilities of having Novavax put to them even more, investors could sell cash-covered puts deeper in-the-money, say at a strike price of $125.00 US, expiry date Friday, July 31, (NVAX P 31JUL20 125.00). That gave option sellers $5.00 US per share last Friday.
That works out to 5.00/125 x 100 = .8% for the week. Not nearly as interesting.
Investors could explore different strike price levels with expiry date on Friday, July 31 and decide what they like best concerning premiums and the possibility of having the security put to them.
Canadian investors need to do this outside their tax-advantaged portfolios. (RRSP’s, RIF’s, TFSA’s and RESF’s) Selling cash-covered puts is not permitted within tax-advantaged portfolios in Canada.
Canadian investors who are in cash within their tax-advantaged portfolios because they were assigned on their covered calls, need to buy the underlying security on which they wish to write covers calls, as a first step. Following that first step, they can write covered calls again, using that underlying security.
As an example, selling Novavax covered calls on Monday, July 27, at a strike price of $140 per share, expiry date on Friday, July 31, (NVAX C 31JUL20 140.00 US) is far enough out-of-the-money to reduce the chances of being called away and yet it gives a premium of $6.55 US per share.
That works out to 6.55/140 x 100 = 4.68% for the week!! It gives some protection from having the security called away.
Members wanting to make money from derivatives (puts and calls) need to observe the following criteria:
- Only sell and never buy derivatives.
- Use an underlying security that you would be happy to own forever. Novavax might not qualify.
- For best returns, sell just out-of-the-money covered calls and just in-of-the-money cash-secured puts. The further out-of-the-money covered calls and in-of-the-money cash-secured puts are sold, the smaller the premiums received but the chances of having the security called away or put to the investor respectively, is lowered.
- Target a return of 1% per week or more.
- Be prepared to get assigned.
What are the risks with the above approach?
If you use an underlying security that you would be happy to own forever, the long-term risks are close to zero.
And the near-term risk? With covered calls, value of your underlying security could drop to a greater extent than the premium that you received. You would have a losing transaction. If you hold it long enough, it will become a long-term situation.
With cash-secured puts, the underlying security could be put to you above the market price. You could then write covered calls on it again.
The reliable, evidence-based way to invest follows:
- Save 10% of income beginning early in life.
- Dollar-cost average it by buying one of the few ETFs which mirror the S&P 500.
- Do so in tax-advantaged portfolios.
- In retirement withdraw 4% of portfolios to live on.
This is Paul Samuelson’s watching-grass-grow or paint-dry approach to investing. Other methods such as derivatives investing or day-trading could outperform the above, but they are unlikely to do so consistently in the long term.
Concerning the second point, at a young age is a good time to explore stock picking as well. The possibility of doing so successfully over the long term is slim, but it can happen.
Day-trading for a living? Who wins? Wall Street brokers! Every time!
Individual investors? Over an extended period, rarely.
The Monday Morning Millionaire Program was designed to offer compressed investment opinions. Over the last two decades, these have outperformed over 90% of portfolios including professionally managed ones.
The program does not provide any investment advice or endorsements.
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