84% Of Investors Are Doing It… Are You?

| February 2, 2010

I just heard an amazing statistic.  According to one major brokerage firm (who will remain nameless), 84% of their active traders are using a simple strategy to make money in the markets.  It’s a strategy that works best when markets are trading flat or slightly up.

The strategy isn’t complex… and today I’m going to walk you through it.

It’s a great way to squeeze more profit out of your portfolio.   As a matter of fact, I occasionally use the strategy in my IRA and trading account.  I’ve done quite well with it.

What strategy am I talking about?

Covered calls.

If you already know about this strategy, hang in there, I’m going to share a great trading opportunity in a moment.

Here’s a quick overview of how this strategy works.

A covered call strategy is a simple way to generate cold hard cash from your current portfolio.  Let’s say you bought 100 shares of General Electric (GE) at $16.15 a share.  Your total cost is $1,615.  Other than a small dividend, you really don’t have a way to make money from GE… unless you sell a call option.

Some of you are asking – “What’s a call option?”

As a seller of a call option, you agree to sell another investor your 100 shares of GE at a set price (called the strike price).  There’s a catch.  The option also has an expiration date.  So for example, you can agree to sell your 100 shares of GE to another investor for $17.00 any time between now and September for about $110 (the option premium).

If GE’s stock stays below $17, you get to keep the $110 and your 100 shares of stock.

Let’s do a little math.  If the option expires worthless and you keep the $110… it’s a return of about 6.8%, not bad.  Remember though, you can always sell another option and capture another option premium.  Over the course of the year, you can earn 10%, 12%, or even more on your investment.

If GE moves above $17, your shares will be “called away”.

You must sell the option holder your 100 shares for $17 a share.  But is that so bad?  You get to keep the option premium of $110 plus the sale proceeds of $85… that makes a total profit of $195 cash.

It’s a return of over 12%.

Better than the measly 3% gain you would have had on the stock alone… right?

Now like any trading strategy, there are some other nuances and risks.  But you get how the strategy works.  You can rack up nice gains day in and day out just by selling options against your portfolio.

Of course, I took a look around and found a really interesting covered call opportunity.

Take a look at Sprint Nextel (S).

Sprint’s stock is trading right around $3.44 a share… and they have a $9 billion dollar market cap.  I’m sure you’ve heard of the company, they offer wireless phone service all over the United States.  They do about $8 billion a quarter in sales and have been struggling to make money.  (That’s probably why the stock is trading so low.)

You can buy 100 shares of Sprint stock for about $344.

Right now, the June 2010 $5.00 call options are trading for an option premium of $0.60.  In other words, you can sell one option (representing 100 shares) for $60.

You can buy the stock for $344 and immediately sell the option banking a gain of $60.  It’s an instant return of about 17.4%.  And that’s if the stock doesn’t move up.

If Sprint trades above the $5 mark, you get to keep the $60 plus you get the profit on your 100 shares.  It’s $156 for the shares and $60 for the option premium.  Your total return would be $216… or 62% on your money between now and June!

The big risk is the stock falling in value or the company going belly up. With $3.6 billion in cash on the balance sheet, bankruptcy isn’t an immediate threat.  And the share price already factors in the worst case expectations.

This is one idea.  There are hundreds more out there.  Keep your eyes peeled for them.  Before long, you’ll be part of the 84% using this strategy in your own portfolio.

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Category: Options Trading

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The Dynamic Wealth Report works with a number of staff writers and guest experts who specialize in everything from penny stocks to ETFs to options trading. These guest analysts post under the 'staff writer' moniker for ease of use.

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