compound interest Sep 22, 2011 1% Per Month Can Make You Rich

When asked to name the greatest invention in human history, Albert Einstein is rumored to have replied "compound interest."

Whether Einstein actually said that or not, the fact is that many smart people take advantage of it. It has been said that if you understand it then you will receive it, and if you don't then you will pay it (usually in the form of credit card debt).

Compound interest occurs when the interest is added to the principal so that from that moment forward the interest itself also earns interest.

In the context of covered call investing, the "interest" is the option premium you receive and the "compounding" is the fact that you reinvest your gains each month.

The main advantage compound interest has is time. The longer you let it run the more impressive the results. Even a relatively modest return of 1% per month is enough to double your money in less than 6 years. Let's take a look at various rates of return (examples assume a tax-deferred account, but even in a taxable account the results are impressive):

Initial Investment Monthly Gain Months Needed To
Double (2x) Investment
Final Value
$10,000 1%/month 70 (5.8 years) $20,068
$10,000 1.5%/month 47 (3.9 years) $20,133
$10,000 2%/month 36 (3 years) $20,399

If you have more time, you can 3x or 4x your investment:

Monthly Gain Months Needed To
Triple (3x) Investment
Months Needed To
Quadruple (4x) Investment
1%/month 111 (9.3 years) 140 (11.7 years)
1.5%/month 74 (6.2 years) 94 (7.8 years)
2%/month 56 (4.7years) 71 (5.9 years)

So, if you are patient and disciplined, you could 4x your investment in 11.7 years if you can get 1%/month. That may seem like a long time but slow and steady wins the race.

Now, in the real world no one is going to achieve 1%/month for 140 straight months. Some months you'll do better and some months you'll do worse. But if you target slightly higher than 1%/month, say 1.3% or 1.5%/month, then the months you exceed 1% should make up for the months you come in below that.

How To Get 1%/Month?

The most conservative way is to sell short-term deep in the money calls. If you don't want to take single-stock risk then do it with ETFs.

One of Born To Sell's tools is called "Max Protection" which is a covered call filter where you enter your desired Annualized Return If Flat (12%, for example, if you are targeting 1%/month) and then it shows you all matching covered calls and sorts them by Downside Protection. If you have a 'return goal' then this is quite the time saver to help you identify possible trades.

Here are some potential 1%/month (or better) ETF trades that the tool found for the Oct 22 expiration date:

Symbol ETF
Price
Trade Downside
Protection
Annualized
Return If Flat
XLF 11.51 Sell Oct 9. Net debit 8.90 23% 13.4%
EEM 35.19 Sell Oct 29. Net debit 28.64 19% 15.8%
SLV 35.76 Sell Oct 30. Net debit 29.71 17% 12.2%
IWM 64.52 Sell Oct 55. Net debit 54.44 16% 12.2%

Each of those ETFs would have to fall by the amount of downside protection listed before you would lose money. And if they stay above their deep-in-the-money-strike prices by Oct 22nd then you will make a minimum of 1%/month. Note that many of them have already come down quite a bit in the last couple of months. While they could fall an additional 16% (or more) in the next 30 days, it seems like a reasonable risk to take (and 1%/month beats the interest you'll get on cash or bonds right now).

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