“Scary” Secret To BIG Trade Wins

Dear Rich Lifer,

The current market volatility is crushing a lot of people – both emotionally and financially.

But you can easily turn the entire situation upside down and use it to generate terrific income.

In past articles, I’ve given you specific examples from my own portfolio – everything from a new allocation to silver via the SLV ETF to a couple short-term trades I made on big-name oil stocks.

Today, I want to talk about another move I recently made – this time on Philip Morris International (PM).

I initially purchased 100 shares of the well-known tobacco company during the market collapse on March 20th at an entry price of $61.71.

By April 6th – roughly two weeks later – the stock had already bounced back to $75.68.

So I was sitting on a paper gain of roughly 22.6%.

Not bad for putting some money into a conservative company that shouldn’t see much of a drop in business, no matter how bad this crisis gets.

[Safe] Gains on Top of Gains

Of course, why not hedge my bet and generate some extra income?

To do so, I decided to sell a covered call against my underlying shares in PM.

A quick recap of covered call writing:

When you write a call option, you are selling another investor the right to buy shares from you at a predetermined price …

As with most contracts, there is a timeframe involved …

And as the person selling the contract you collect an upfront payment, known as a premium.

Like I always point out, it is entirely possible to sell calls without owning the underlying stock, but that strategy is only appropriate for the most aggressive investors — and it carries substantial risk of loss.

The Safest Way to Use Options

In contrast, covered call writing is quite conservative because you are only committing to sell shares that you already own. Better yet, you always know well in advance what all the potential outcomes are.

For my Philip Morris International position, I decided to use a price just a bit higher than the current one and a timeframe of less than two weeks.

The specific trade: Selling an April 17th contract with a strike price of $77 a share.

In doing so, I collected $200 upfront.

That will be my money to keep no matter what happens next.

Maybe $200 doesn’t sound like a lot of money.

But look at it this way: That’s an extra 3.2% on my original $6,171 investment.

It’s worth almost two quarters of regular dividend payments from PM.

Meanwhile, the contract will expire in less than two weeks.

On an annualized basis, I earned more than 80%! (3.2% times 25)

And what did I risk?

Well, here are all the possible outcomes of the covered call trade: 

A. PM can rise further and if it goes above $77 the holder of my contract can take my shares away at that price.

Under this scenario I’ll keep my premium and earn an overall capital gain of about 24.7% on top of the 3.2% premium yield for a total return of 27.9% in less than a month total holding time.

B. The same as above, only the contract holder may decide not to exercise the option even if it’s in the money.

This will often happen when the options are just slightly in the money, or the contract holder is using the option as part of some larger strategy.

C. PM could stay under the strike of $77 at expiration day.

Under either B. or C., the result is the same: I’ll keep my shares and the premium.

For me, any of these scenarios are great!

Plus, if PM pulls back sharply at any point between now and then, I can also go out and buy the exact same call myself (known as “buying to close”).

In doing so, I will effectively cancel out the contract I initially wrote – permanently pocketing the difference between the premium I originally collected and the amount I paid to buy back the contract later.

How Can You Use This Example In Your Own Investments?

Assuming the market volatility continues, it might be possible to do this type of trade over and over again on the same 100 shares of Philip Morris International.

Also remember that over the lifetime of each covered call trade, I can continue to collect any dividends paid out to PM shareholders.

You can see why this strategy makes a lot of sense for a conservative income investor, especially in the kind of environment we have right now.

In my particular case, I just got an extra cash payment … hedged against additional market downside … and am only risking a very nice realized capital gain.

Best of all, I might be free to do the whole thing all over again two weeks from now.

To a richer life,

Nilus Mattive

Nilus Mattive

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Nilus Mattive

Nilus is the editor for the daily e-letter The Rich Life Roadmap and a Paradigm Press analyst.

Nilus began his professional career at Jono Steinberg’s Individual Investor Group, where he published his original research through a regular investment column. Later, he worked for a private equity business and spent five years editing Standard and Poor’s...

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