We saw some decent buying on Tuesday but overall, stocks have been languishing early on in 2014, which has some traders concerned that a correction may be brewing.
However, I’m not sure that’s the case. The stock market may just be taking a breather following its superlative gains in 2013. I’m not surprised; in fact, I expected this would happen.
This year will likely be a more difficult year to make money, as the market is looking for reasons to buy. I still feel the direction of the stock market will be up, but it will be at a slower rate.
Now, if the stock market should continue to stall or gyrate in a sideways channel around record highs, you could take advantage of this without adding stocks.
You can earn daily income on your existing stock market holdings without having to pick up dividend stocks or shift capital into low-paying bonds. And my strategy is pretty easy and straightforward.
I’m referring to the use of writing covered call options on some of your key long-term core holdings to generate premium income and reduce the average cost base of your positions. By writing covered call options on your existing holdings, the premium income added could allow you to earn some daily income. But you need to be comfortable with possibly losing a holding.
For those who are not familiar with covered call options, the execution is simple: all you do is sell or write call options on one of your stock holdings, and in return, you’ll receive a premium for assuming the risk. You select the month of expiry and strike price, which is the price at which you are willing to sell your stock to the buyer of these call options. Make sure you are comfortable with the upper strike price of your covered call options and that it’s above the key resistance for that stock.
Let’s take a look at Cisco Systems, Inc. (NASDAQ/CSCO) as an example. Assume you own 100 shares of Cisco at a cost base of $15.00 per share. You are already up $7.47 a share based on the prevailing market price of $22.47 as of January 14.
Now, say you continue to be long-term positive on Cisco, but at the same time, you feel the stock may pause or move lower over the next quarter (in the shorter term).
There are several strategies at your disposal. You can sit on the position and wait for the stock to rise, but the problem with this strategy is that it’s an inefficient use of capital, at least in my view. So why not make your capital work for you?
One easy way to do so is to write covered call options on your holding of 100 shares of Cisco. For every board lot (100 shares) of Cisco, for example, one call option may be written.
If you think Cisco is dead money for the next several months, you could write an out-of-the-money July 19 $24.00 covered call option for a premium of $68.00 per contract, or $0.68 per share. If Cisco does not break above $24.00 by the July 19 expiry, you keep the $0.68, which is a return of 4.53% based on the $15.00 stock price.
Covered call options writing is straightforward, low-risk, a generator of premium income, and a guarantee of the selling price for the stock. I have long favored the use of covered call options on long positions should the market trade flat or downward, or when you want to hold stocks. And that just may be the case now.
So if stocks stall, make some money and write some covered call options.
This article Risk-Free Daily Income on Your Existing Stock Holdings? was originally published at Daily Gains Letter.