“It takes money to make money.”
This truism has likely been around since the creation of money itself. Covered Call Writing Demystified is designed for people who already have money…either quite a lot of it, or some of it, and the ability to add to it on a regular basis. It is for those who want first to preserve their money from the effects of inflation and also want to make it grow to support them and to add to their wealth while assuming an acceptable amount of risk commensurate with the return.
Keeping our money and making it grow has been a difficult proposition in the last decade. As of this writing, the Standard & Poors® 500 Index has gone absolutely nowhere for the past twelve years and has declined by over 30% in the past ten years. Many investment experts and economists believe that, at best, investors may realize from five-percent to seven-percent annual returns before taxes and inflation going forward.
With such past results, and if predictions for the future by some experts are close to accurate, new ideas will be needed if stock market investors are to have any hope of achieving consistent double-digit returns in the future.
Will the stock market only grow by five-percent to seven-percent annually, on average, for the next fifteen to twenty years as many experts have projected?
Will stock investors still seek to achieve greater than five-percent to seven-percent annually on their investment assets?
If both of these questions are answered affirmatively, another important question needs to be answered: In this environment, what investment vehicles are capable of achieving greater than average stock market returns in the future? For most prudent investors, the possible choices are:
Tangible investments, gold and other precious metals – Very unlikely to outperform, as these assets rise in value primarily in a high inflationary environment and in times of ongoing crisis. Economists are generally predicting deflation or low inflation for the immediate future. And even in today’s tense international environment that may cause short-term swings, the long-term outlook would not point to outperformance of such assets.
Bonds – While there may be some additional capital appreciation potential in bonds should interest rates come down further, the coupon rate on bonds is already historically and artificially low due to government intervention in the markets. They have appreciated very substantially in recent years. Bonds can provide an important fixed income component to a well-balanced investment portfolio, however, bonds do not outperform stocks over long periods of time.
Real estate – Significant future appreciation may potentially occur in well-selected real estate investments, although real estate of all types has decreased precipitously in value in recent years. Such investments are, however, generally quite illiquid. Investment advisors suggest only a small portion of investable assets should be placed into real estate investments.
Stock selection – Some investors may feel that they can “beat the market” by diligent stock selection. This has proven to be illusory over long periods of time, even for professional portfolio managers with the very best track records.
Covered call writing – Using standardized, exchange-traded options for covered call writing on common stocks, the combined return to the investor from potential capital appreciation, stock dividends and option premium income can result in double-digit yields…more predictably and conservatively than with common stocks alone. Covered call writing is a new subject for many individual investors and is misunderstood by many others.
The program outlined in Covered Call Writing Demystified, a combination of prudent ownership of common stocks coupled with writing covered call options on them, provides what may be one of the best opportunities to achieve double-digit investment returns in the future.
The investment strategy known as covered call writing involves the ownership or purchase of common stocks on which call option contracts are sold (written). By selling call option contracts on stock, the investor receives current income from option premiums, in addition to any dividends, and a defined amount of capital appreciation potential on the stock. This approach is more conservative than simply owning stocks. It can provide more stable, predictable, and higher investment returns than stock ownership alone in a slower growth or volatile stock market.
This book may be the only title exclusively devoted to the subject of covered call option writing that presents the subject material in a manner easy for the reader to understand and with a personal investment program for implementation by the reader. Software templates for a personal computer using Microsoft Excel® are provided with the book to assist the user in formulating investment decisions on covered call writing opportunities, for tracking results and to assist with other financial planning decisions.
This book is written as a novel for easy readability. Yet its purpose is to serve as a hands-on, practical workbook for individuals who seek to achieve a consistent double-digit total return compounded annually on the common stock portion of their investment assets year after year.
No doubt one of your goals is to build wealth in anticipation of retirement someday, or perhaps you are already retired and are simply attempting to earn more than you currently spend to improve your standard of living. Also, rather than just leaving a will that says “Being of sound mind, I spent it all,” you may wish to leave a legacy to family and charity. Consistently earning an above average real (after inflation) rate of return on your investments is critical to successfully achieving such financial goals.
Individuals with an investment portfolio of self-managed personal and retirement accounts are the primary intended audience for this book. These would typically be individuals who are finishing or have completed their strongest asset building years…people in their mid-fifties or older who have been accumulating assets for retirement or who have achieved their asset accumulation goals and are now retired.
Another audience consists of the many investors who have fewer investment assets, but are in a position to add substantially to them on a regular basis in the future. The growth of Exchange Traded Funds, and the increasing number of option investment products available in conjunction with them, provides this very large investor population with an opportunity to utilize the program outlined in this book. Such individuals would range in age from the twenties through mid fifties. The baby boom generation constitutes a huge portion of the higher-aged end of this profile group. These individuals are projected to substantially add to their investment asset wealth as they approach and enter retirement. They will inherit record amounts of assets in the near-term future.
Many people spend little time actively managing their investments. Such neglect leaves them open to the influence of advertising, suggestions from friends and relatives, or worse. It’s no wonder so many investors end up on the wrong path. Yogi Berra’s confusing directions, “When you come to a fork in the road, take it!” isn’t far from reality for some.
This book will introduce a program most likely new to you. When implemented as suggested, it will help you find a new road and keep you firmly on it.
As a bank president, I was always amazed by how many customers would leave large sums in non-interest bearing checking accounts or very low-yield checking or savings accounts, without apparent concern for the paltry or non-existent returns that they were receiving. Such a passive approach to investing reminds me of an out-of-touch person who was asked whether he believed that there was widespread ignorance and apathy among the population. He responded, “I don’t know and I don’t care!”
People who place their money in bank certificates of deposit (CDs) or Treasury securities would love to get even a seven-percent rate today on their funds. Some have had an opportunity to earn as much or even more in the past. Now such a return on these investments is no longer even remotely possible in today’s economic climate, and there does not seem to be much hope of achieving it anytime soon. Of course, we can assign some value to the fact that bank and savings and loan deposits are insured and Federal government securities are guaranteed.
Others who have been heavily invested in common stocks have achieved double-digit returns in some years, but have seen huge swings in their investment portfolios as they have taken big risks without fully understanding them…especially in the technology sector. Well-respected experts tell us it is extremely unlikely that those large returns of the past will be achievable in the future through traditional stock investing. Historically there has at least been some stability from the dividends shareholders received on their stocks. Now more and more companies pay no dividend. And for those that do, the return to the investor based upon the market value of their stock is pitifully low.
Yet, achieving high rates of return always remains a fundamental goal for investors under any investment climate…if we can only determine how to do it. Let’s take a look at the dramatic difference a higher return can make over time. For purposes of simplicity, we will assume that an investor has an initial investment of $100,000 in a Roth IRA account. Therefore, there are no taxes to pay on investment gains and income. The difference in the value of the account over many years can be staggering. Consider the implications if it were possible to achieve a fifteen-percent compounded annual return.
The program provided in this book to assist you in achieving double-digit compounded annual returns might be more conservative or more aggressive than your current investment approaches. Suffice it to say for now that the program involves more risk than placing your money in a bank, but less risk than simply being invested in the stock market.
Actually, a strong case can be made that leaving a substantial portion of your investments in lower return fixed income assets, such as CDs, savings accounts, bonds or mortgage investments, may in the long run be higher risk than the program presented here. The ongoing ravages of inflation continue to gnaw away at our collective net worth year after year, even at today’s lower inflation rates. With only a three-percent annual inflation rate, the purchasing power of our money would decline by half in about twenty-four years. And, if we ever get back to the six-percent inflation range again, it would be cut in half about every twelve years. Never underestimate the ability of inflation to diminish our purchasing power over long periods of time.
By achieving a double-digit annualized return, an investor could expect to outpace inflation many times over. Most people would be able to add considerably to their net worth each year or could produce extra income to cope with rising expenses and improve their overall standard of living.
It is true that investments in some common stocks have yielded annualized returns, almost entirely from capital appreciation, of greater than fifteen-percent in some years. Yet a close examination would indicate that few have been able to achieve these results consistently over very long time periods (Warren Buffett excepted, of course). A large number of stocks have declined in value, with major stock indices being down by over 30% in the past decade. And the stocks that have previously performed so well, are now selling at a fraction of what they were in the past after one of the most precipitous market corrections in history.
If you are currently a stock market or equity mutual fund investor who makes your own investment decisions, regardless of the size of your portfolio, and would like to add more stability and predictability to your investment returns and be afforded some protection in a down market, then this book is for you. If you have typically kept your assets in bank deposits, are not happy with your investment returns, have considered going into the stock market, but are concerned about the risks, then this book is for you. If you are interested in stock market investing, but your investment resources are limited, yet growing, this book is still for you. As diversification is important in all investment programs, note particularly the chapter on Exchange Traded Funds (ETFs) and how to use them in this program. If you do not have the patience or desire to manage your own investment portfolio, this book is for your investment advisor or financial planner.
If you would be unable to sleep at night by having some of your money invested in the stock market, then this book may not be for you…but read and work through it anyway. You might change your mind and come to the conclusion that being out of the market also has its risks.
This book is for those who believe that long-term inflation is always a risk to overcome, but are concerned that the stock market alone may not provide the returns that it has in the past. It is for those of you who hope to still achieve a double-digit annual return on your investments despite predictions of a slower growth market and significant market volatility. If you are willing to take some risk to accomplish this, but not as much risk as just being in the stock market alone, then this book is for you.
By reading the story, following the numerous examples, and using the tools in this book, you will have a viable means of working towards this worthwhile objective.
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