I was having a conversation yesterday with a very wealthy man.
He is retired and has roughly $60M almost entirely in tax-free bonds that gives him roughly $4M a year to live on and he has a very nice life. I was, of course, mortified by his investing strategy but I’m also half his age with quite a bit less than half his wealth and I asked him if he had ever considered options which, in turn, mortified him.
"Those things are a scam, you can never win," he said. Rather than attempt to persuade him over lunch that a diversified virtual portfolio of options can perform as well as a diversified virtual portfolio of stocks or bonds, I just illustrated one simple thing to make my point and it occurred to me that many new members would appreciate the same thoughts so here is my advice to anyone who wonders if options can work for your virtual portfolio:
I asked him what company he would consider investing in. Which one stock does he, a man who thinks the whole market is a scam to be avoided, would he be willing to risk putting 10% of his assets into. After some consideration my friend said "GE." Just because he thinks it’s a scam doesn’t mean he doesn’t follow the markets and he is well aware that GE has lost 30% of it’s value since October and is trading back at the price it was at in 1998 "before it went crazy."
Of course I agree with that. GE has been caught up in the financial crisis, even though it’s only half a financial company and the forward p/e of 11 is lower than it has been at any time in the past 20 years. GE is, of course, a company we can expect to be around for the next 20 years and has effectively been around since 1890, when it was called the Edison General Electric Company, it’s an original Dow component and a perfect choice for an 80-year old man who doesn’t trust the markets!
GE pays a taxable dividend of 4.5% but has underperformed the Dow by 30% over the past two years. GE has been so bad lately that even I gave up on them (they have been out of all our virtual portfolios for quite some time), but that certainly doesn’t mean I feel they are going out of business. So whether it’s GE or any other company you have long-term faith in (preferably one that pays dividends) – here is a very simple strategy for making 20% a year on your investment.
- Buy 100 share blocks of GE for $27.38
- Sell the July $27 calls for $1.31
That gives you an effective purchase price of $26.07 and if GE closes at $27 or more on July 18th, you will get your stock called away for a 3.5% profit in your first month. If it heads lower you, of course, keep the caller’s money and, since GE has strikes for sale at each $1 mark down to $22.50, as long as it doesn’t go below that you can sell the August whatevers for another dollar and September and October and November and December…
Since you will collect $1 per month every month every month against your stock, GE will have to fall more than $12 per year for you to lose out on the downside. After two years of selling monthly calls for $1, you will have collected $24 against what started out as $27.38 shares of GE along with $2.46 in dividends, that’s 96.6% of the original purchase price returned in sales and dividends over 2 years.
Can it possibly be this simple? No silly, if it were, then I would be much richer than my friend by now. Whenever you get called away you have to decide whether it’s worth buying your shares back again. Sometimes you will get called away right before dividends and sometimes the stock may drop faster than you can cover (but this is why we stress our "rolling" strategy to members). You will not make 3.5% every month like clockwork otherwise this article would be called "Can You Be Satisfied Making 42% Returns Each Year" (and that still wouldn’t include the dividends) but, I can tell you from my experience and the experiences of our members, that 20% a year is a very reasonable rate of return to expect following this strategy.
It’s not exciting, it’s not sexy, it will not make you rich overnight so the question I put to you is "CAN YOU BE SATISFIED?"
In our own Stocks Virtual Portfolio we follow a dual strategy of selling covered calls like this example or selling puts ahead of buying a stock, which is our preferred method of entering a stock play and has been previously discussed at length (see K1 Project). We reset our Stocks Virtual Portfolio one month ago with $250,000 and all of our positions closed or were called away this month, leaving us with $273,650 in cash after 30 days. That’s 9.5% in a month – CAN YOU BE SATISFIED?
Not everyone has the time to sit around all day watching their stocks and options and last week was an excellent example of how missing a day or two of trading can torpedo your virtual portfolio but this is a strategy that can be pursued as long as you show up to trade on options expiration day each month. Can you be satisfied with that?
20% annual returns are nothing to sneeze at. $5,000 invested at 20% compounded over 20 year gives you $191,688, that should keep you ahead of inflation! Starting with $12,500 and adding $2,500 a year to the account over the same 20 years nets you $1M in 2028 so if you really want to be a millionaire when you retire, stop gambling and take a portion of your income and start investing!!!
"The man who begins to speculate in stocks with the intention of making a fortune usually goes broke, whereas the man who trades with a view of getting good interest on his money sometimes gets rich." ~ Charles Dow, 1901
I resolve to spend more time in our Stocks Virtual Portfolio, teaching members what to look for in opportunities as we use stocks as a vehicle to become sellers of options – learning to BE THE HOUSE, rather than the gamblers. Once you establish a solid base in an account that grows steadily each year THEN you can play the short-term options game FOR FUN. If you’re not having fun – then what is the point? If you are not making progress towards your retirement goals – then what is the point?
We’ve been having so much fun this year playing our short game that sometimes we forget to pay attention to the basics and that is a disservice to our newer members, who missed out on my first year of preaching way back in 2006 and early 2007, but they are archived and many of those strategies are linked throughout the K1 Project.
Sage, K1 and I are in the process of putting together a book that will address many of these issues but, for now, let’s get back to basics with our Stocks Virtual Portfolio as making 20% can be very satisfying indeed in flat to down markets!
