For most investors, the grasp of financial markets is confined to stocks, bonds, real estate, and mutual funds...
Options trading is a foreign concept, deemed too complex to use effectively.
But to shun the use of options is to deprive yourself of the opportunity to achieve outsized gains, reduced risk, and earn income.
As you may already know, an option is just a simple contract that gives you the right to buy or sell shares of an underlying stock at a set price (strike price), by a set date (expiration date).
There are two types of options: call options and put options...
Now the thing about options is that you can buy them... and you can sell them.
Because of a number of factors that work against you, buying options can be risky.
That’s why in In the Money, we only sell options. It fits our objective perfectly, which is to make regular income to complement our long-term stock holdings.
I want to quickly walk you through a recent example where readers made a 17.82% gain on a stock with the help of conservative options strategies.
Covered Calls—The Gifts That Keep on Giving
In a recent edition of In the Money, we detailed why US defense contractors looked like a good investment.
So, we vetted several of the industry’s biggest players using EES... and a clear winner emerged.
Based on favorable macro trends and a solid EES score, Huntington Ingalls Industries (HII) looked like a stock we wanted to own.
But you’ve already seen the excellent job EES does at identifying solid companies, that’s not what we want to show you...
As gains in defense stocks usually build slowly, we wanted to invest in such a way that readers wouldn’t have to wait to take full advantage of HII’s positive outlook.
That’s why we recommended a put option strategy. If you’re unfamiliar with this simple strategy, here’s how it works:
First, we bought 100 shares of HII at the market... our entry price was $144 per share.
In the same window, we sold a call option, known as a covered call, on those shares.
Two things happened when we did this.
To start, we received $275 in option premium immediately. In the world of options, the buyer always pays the seller a premium—one of the reasons we prefer being the seller.
Secondly, when we sold the call option on HII shares with a strike price of $150, we knew it would lead to two possible outcomes, both of them to our benefit:
Shares of HII close above $150 at expiration: If this happens, we would be forced to sell our shares at $150—a profit of $6 per share... plus, we would keep the $275 in options premium.
Shares of HII close at or below $150 at expiration: Nothing happens. We get to keep our shares and the $275 in options premium.
As HII shares traded above the strike price on the expiration date, they were “called away,” meaning we were forced to sell them... for a 4.2% profit.
When the options premium and dividends we received were added, the gain came to 6.42% in just two months. That’s a 38.52% annual return.
Using covered calls, we structured the position to make it a “heads I win, tails I win” scenario. HII is a company we wanted to own, but we were also happy to take a 6.42% profit on the position.
And that was only the beginning...
HII’s share price dropped just 14 days later, which was a great opportunity for us to add this solid company back to our portfolio.
As before, we sold a call option and immediately pocketed $544 options premium this time.
And again, as the shares traded above our strike price of $180 on the expiration date, we had to sell our HII shares... for a 7.12% profit.
The options premium and dividend we earned brought our return to 11.4% in six months.
In total, our two consecutive trades with HII delivered In the Money readers a return of 17.82%.
As you can see, covered calls are an excellent way to generate income while holding a stock you already want to own.
Along with selling call options, you can sell put options... which can prove even more profitable for your portfolio.
Puts—Buying Your Favorite Stocks on Sale
After collecting profits on HII shares, we were interested in adding the company back to our portfolio.
But HII had been on a hot streak, and we wanted to buy it on sale... so instead of buying the high-priced stock outright and selling call options, we sold put options...
This means, rather than having to sell our HII shares if they closed above the strike price, with put options, we would have to buy HII shares if they closed below the strike price—which would be a good thing since we could add HII back to our portfolio at a much lower price.
To start, we sold the put option and pocketed the options premium, $294 this time.
As HII’s share price didn’t drop below the strike price on the expiration date, we weren’t forced to buy shares...
So we decided to sell another put, and collect $245 with our second options premium.
This time, the shares did drop below our strike price, and we were forced to buy them.
But here’s the thing... we were a fan of HII and its business model and were happy to acquire the shares... at a much lower price—one we chose.
Even better, the options premium we earned lowered our entry price.
So Why Isn’t Everyone Doing It?
You may be asking “if selling options is that simple, why isn’t everyone doing it?”
The big mistake that most people make when selling options is that they do it on stocks they would never want to own.
In In the Money, we only sell options on stocks that we already own or on stocks we would love to own at a lower price... like we did with HII.
The strategy of In the Money is simple: use options to reduce downside risk, generate income, and own shares of a desired company at a better price.