Spoiler alert: Postponed: 2020 Cannes Film Festival!
If we're ever able to flight around the globe, looking rich & fabulous, you're going to want to stock up on cash flowing option strategy, that's fairly low risk to fund your luxury lifestyle.
Plus from your overflow be generous and feed those in need!
If you are a long-term buy-and-hold investor, there is an options strategy that you should get down and dirty with. It’s called the covered call strategy, and it involves a combination of stocks and options. The covered call strategy is a mildly bullish options strategy and can earn you extra income on the shares they own.
Its a more difficult strategy to implement in a bear or highly volatile market, and in those situations, you should reduce the option expiry down to 30 days. In South Africa, we believe the only brokers that offer Covered Calls, is Standard Bank Online Share Trading, with a 3 month expiry, so we write options about 30 days from expiry.
The Mechanics of the Covered Call Strategy
A covered call strategy is an options strategy that allows a trader or investor to collect additional income on a stock they own. Using covered calls is considered only a mildly bullish strategy because the upside of the trade is capped off, unlike a call option or long stock position which have “unlimited upside.”
Why would you do this?
Maybe you believe that the stock (or ETF) you are long on has a limited near-term upside. Instead of holding onto and waiting for the stock to move, you can passively collect income with a covered call. Covered calls are a great way to maximise the profit from a slow-moving stock.
Here’s an example of how it works:
A trader is long on 100 shares of Absa Group ($JSEABG) at R89.77. The total value of the position is worth is R8,977. The investor will be happy if the stock can return 15% over the next year or two, which would take share price to about R103.24 per share. Which is not unrealistic considering, the stock's 52 week range being R63.30 - R182.72 (today's spot R93.73).
Let’s see what happens if they sell the R97.50 call that expires 64 days (17 June) from now. You can expect to earn R 4.12 premium per contract or 4.4% premium as percentage of exposure. Overall projected income: R 354.50 (net income).
This is roughly 2.2% per month, and under bullish market conditions, if you could get 2% on your capital a month, that would be 24% annual. That's definitely a great aspirational return to aim for. And guaranteed double of what a normal, diversified retirement fund would give you. Plus, you may not need to sit on your hands for 2 years to get a 15% return.
Disclaimer: Is not that easy, but we've just shown you the potential. What's really appealing is that a R1M., could yield R20,000 per month (before tax etc).
Quick Google search popped up that a first class flight from Johannesburg to Cannes, will cost you R60,000. That's 3 month's premium income. Booked and done (assuming global lockdown will ever be lifted?).
Ways the Covered Call Option Strategy Makes Money
There are two key ways using the covered call option trading strategy makes you money:
The stock stays flat or declines modestly, or
The stock trades higher.
As you can see, the covered call strategy has more than one way to be a winner, which can be appealing to some traders who are used to trading equities and having only one way to win.
Now, what’s the downside of the covered call strategy?
One of the biggest downsides to using covered calls is that your profit potential is capped of And in bear markets, stocks could far very fast, and the loss in share capital, will not be adequately covered by premium income.
How Should You Trade the Covered Call?
The covered call strategy works well with blue-chip stocks. Most blue-chip stocks have relatively low volatility, and covered calls can help spice up returns by capturing the additional premium. We also like to write covered calls for stocks that have a healthy dividend yield, as institutions like holding these stocks, and are less likely to "crash". Finally, we like up trending stocks.
We hope this post inspires you to explore a world beyond a Buy-Hold & Hope investment strategy.
Live Wealthy & Free.