Bookmark and Share Jul 16, 2018 Get Paid To Wait To Sell Stocks At A Higher Price

by Laurie Itkin

A common investment strategy is to buy a house or apartment and rent it out for income. Frankly, this idea never appealed to me because it just seemed like a lot of work. My mother’s third husband owned a few rental properties in a low-income section of Pittsburgh, PA, where I grew up, writes Laurie Itkin.

It was difficult to evict tenants who were late on their rent. Sometimes his assets were not generating income. I remember how hard my mother worked to clean the apartments after tenants moved out.

If your goal is to generate supplemental income, consider “renting out” your stock. It is so much easier, faster, and convenient. The practice of selling call options against stock you already own is called covered call writing. A covered call consists of two steps: you buy shares of stock (or use stock you already own) and then sell call options against those shares of stock. You can use either stock or ETFs as the underlying security.

A small percentage of financial advisors (including myself) specialize in this type of strategy. It is also something you can learn to do on your own—with some education and coaching—in a self-directed brokerage account or IRA.

Writing covered calls is not a “get rich quick” strategy but is an excellent way to generate income, which you can spend or reinvest. If you like receiving dividend income from stocks, you’ll love receiving call option premium income on top of that. With covered call writing, you can generate income from many stocks that do not pay a dividend.

Which strategy is better: buy and hold or covered call?

Assume Brenda and Carol each buy 100 shares of ABC Company (ABC) at $50 per share. Carol, in addition to buying the stock, also sells one ABC call option with a $53 strike price.

Immediately she receives a $100 premium for selling the call option, which is credited to her account.

While both women made the same $5,000 investment for the stock, one way to think about it is that Carol received a $100 “rebate.” That means that Carol’s cost basis was lowered from $5,000 to $4,900. Similar to a rebate on a product you might purchase, Carol is permitted to use that $100 on anything she wants.

Although Carol received income that Brenda did not, the trade-off is that Carol’s maximum profit is capped at $400 no matter how high the stock goes up in price. That is because she must sell the stock at $53 per share if the call option buyer wants to purchase her stock any time before the option expires.

So, which is the better strategy? Brenda’s buy-and-hold strategy is the more profitable strategy only if ABC’s stock price rises above $54.

If you have a strong conviction that a stock is going to move up in price by a significant amount within a fixed period of time, then you might want to buy stock without selling call options against it.

However, do you ever really know how much a stock is going to increase in value within 30, 60, or 90 days?

If the value of the stock falls significantly, the loss from holding the stock will, in many cases, outweigh the gain you received from the option premium. That means you still need to select high-quality stocks and ETFs that work together in a manner to create a diversified portfolio that reflects your risk-to-reward preference. However, since you also create downside protection by selling call options, you create a cushion you don’t have when you simply buy stock.

Laurie Itkin is a financial advisor, author of Every Woman Should Know Her Options: Invest Your Way to Financial Empowerment, and founder of the site TheOptionsLady.com. This article is reprinted from MoneyShow.com and was published in the Chicago Tribune on July 13, 2018.

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