For the past couple years I have have mostly ignored my Traditional IRA. I would put money into it every once in a while but it would mostly just purchase the only mutual fund that was in it The Fidelity Freedom 2050 (FFFHX). I know that sunk costs shouldn’t matter but I promised myself if I ever got to even I would sell the whole thing and use the couple grand in there to try a trading idea I have had for a while. I WANT CRITICISM PLEASE!
What is a Covered Call?
To understand what I am doing first you need to understand what a covered call is. According to Investopedia a covered call is,
An options strategy whereby an investor holds a long position in an asset and writes (sells) call options on that same asset in an attempt to generate increased income from the asset. This is often employed when an investor has a short-term neutral view on the asset and for this reason hold the asset long and simultaneously have a short position via the option to generate income from the option premium
A covered call has no additional risk then just owning the stock in a normal manner. I actually think it wouldn’t be a hard argument to make that it is less risky as you have actually received some of the money you invested back in cash. This fits in perfectly with my income oriented sense of investing (and my risk tolerance of an 82 year widow).
In a covered call I own (at least) 100 shares of a company I then sell a contract (1 contract = 100 shares) that says if the company reaches $X price (the strike price) by a certain time the purchaser gets the option to purchase the shares at that price. When they are buying the contract they believe that the share is going to be worth more than that amount. For creating/selling this contract I get a sales price.
How I am Going to Invest my Traditional IRA
My goal is to find companies with a market cap of at least $200 Million, a positive P/E, a stock price of below $5.00 per share and are traded on the options exchange. From the remaining companies I will research them one by one to determine whether to move on any of the options available. The covered calls will be out of the money options that will expire within 0 to 6 months of purchase. The strike price will be an amount that I am very okay profit-wise.
My first purchase is a fantastic example of what I am looking to do:
My First Purchase Using Out of the Money Short Term Covered Calls
I have utilized this technique in the past, but never involved my blog which keeps me accountable and has a built in feature of being able to record my moves. Also since this purchase is one that I was involved in before I came up with the screening options it is falls a bit outside of the strict guidelines needed to figure out which stocks/options to even look at. Even though I have done this before this is going to be my first “recorded” move:
- Bought 575 Shares of Sprint at $2.25 on 2/22/2012 (I had a a few in the account to round me up already)
- Sold 6 Sprint Covered Call Option Contracts on 2/27/2012 for a Strike Price of $3.00 in August
I am not an investment or option guru by any means but here is my thought process on the available options:
- Sprint Increases to $3.00+ in August – my shares are acquired at $3.00 for a very healthy 30% gain inside 6 months or so months! Plus my $111.89.
- Sprint stays the same – I keep my $111.89 (which I will reinvest in another stock pick) and the shares remain mine. The $111.89 is about 8.5% of my initial investment! So at risk is really only 92.5% of my initial investment.
- Sprint goes down – I believe in the longevity of the company so this really isn’t a huge deal as I am willing to keep selling covered call until the 3rd largest national wireless provider gets their act together or is acquired.
Screening For my Next Purchase
Using the Criteria above my Stock Screener came up with 25 possibilities. Right on the list, was Vonage (VG) which I am shocked to learn that it is trading at just 1.35 price to earnings and earned 1.72 per share. There isn’t a lot of option activity so not sure I’ll be able to actually sell a covered call so I will watch it in the upcoming months. But for his next purchase I am going with Radian Group (RDN).
- Shares are trading at $3.50 per share
- P/E Ratio of 1.57!
- Activity on the option front
Thinking I can sell the May $4.00 Strike for .30 – .40 per contract so if I can get .30 I will get 7.5% off my purchase price back with an upside of 15%+. Not bad for 2 months! If it doesn’t get called then I just re-sell it for 2 months later again.
Some Final Thoughts
Why Use Stocks Below $5?
I don’t have a lot of money in the account, maybe a couple grand and so I need to be able to purchase enough multiples of 100 so that I can sell a few covered call option contracts to make the $8 fee not seem huge in comparison.
Why in my Traditional IRA?
I don’t have to keep records! The whole thing will be eventually taxable so I don’t have to keep tax records which I believe would be a PAIN in this type of strategy.
What am I missing with this strategy?