“You can’t beat the market, so stop trying.”- CBS News, July 5, 2012
This income myth might be the most destructive for investors, for the simple reason that it has the effect of convincing investors that they should avoid investing their own money at the precise times when they should.
And eventually these investors DO invest their money, usually at the exact wrong times – or using the wrong investments.
But if the next year is anything like the preceding 40, then with a few simple transactions, you (or any investor) can outperform the market by a wide margin.
You can beat the market.
In today’s issue, I’m going to do something I don’t normally do. But it’s the holidays, and I know not many people will read this – so I’m going to reveal exactly how you can beat the market starting today.
First, you should know I’m speaking from experience. I’ve been using a variety of income strategies to help individual investors succeed for over a decade. Over the past year, for instance, ONE simple income strategy I wrote about in my service High Yield Trader helped my readers outperform the S&P 500 by over 7%.
More importantly this strategy involves LESS risk than simply buying and holding stocks.
And unlike most investment strategies, our High Yield Trader strategy locks in monthly gains to allow for a steady stream of income. Yes, almost every known sector outperformed the market in 2013, but how many actually locked in those profits? If not, they are only paper profits and are, well, meaningless.
So it’s time…all investors, especially income investors, need to take a serious look at covered calls.
A covered call is a conservative options strategy whereby an investor holds a long position in an asset and sells call options on that same asset to generate increased income. Unlike buying options outright, this strategy allows you to take a conservative stance so you can sleep well at night.
If you own at least 100 shares of stock, then you have the ability to “sell a call” against your stock (assuming it has options, which most do). Remember, 100 shares of stock equals one option contract.
One of the stocks I use for covered calls is Microsoft (NASDAQ: MSFT). Let’s say that you’ve collected 200 Microsoft shares over the past few years and would like to use your shares to generate a steady stream of income and beat the market. You believe in the long-term prospects of the company and have no intention of selling the stock any time soon … it’s a long-term investment.
With Microsoft trading at approximately $37.50, the 200 shares are worth $7,500. Again, you like the stock’s long-term prospects but feel in the shorter term that it will likely trade relatively flat to lower, perhaps within a few dollars of its current price of $37.50.
If you sell two February (expires on February 21, 2014) call options on MSFT at the $40 strike (this means you are selling the right for another investor to buy your shares for $40 at any point up to February 21), you could collect $50 per contract, or $100 for your 200 shares. Sell a call six times per year on MSFT and you could bring in $600 or 16% in income. Moreover, if MSFT moves past the your short call strike of $40 you would lock in 6.7% in just 56 days, plus the $100 of premium you brought in from selling the $40 call.
Quick note: The further you move your strike price away from the current stock price, the higher your probability of success (defined as your shares not being “called away”). We just happened to choose $40 for our call strike, but if we chose $41 the chance of being called away decreases significantly. However, here’s the kicker, the more conservative your approach, the less option premium you bring in.
Anyway, returning to our Microsoft example, one of three scenarios will play each and every time you sell a call:
1) MSFT shares trade flat (below the strike price) – the option will expire worthless and you keep the premium collected when you sold the calls. In this case, by using the covered call strategy you have successfully outperformed the stock.
2) MSFT shares fall – the option expires worthless, you keep the premium, and again you outperform the stock.
3) MSFT shares rise above your strike price – the option is exercised (i.e., your stock is called away) and your upside is capped at your strike price plus the option premium collected.
Given how this conservative strategy works, why would any investor choose to shy away from such a proven income strategy that has outperformed the market and dividend-paying stocks over the long term?
You can learn more about how I safely use options for both income and to steadily grow my investment account by clicking here.