I Just Made This Tax-Free “10% Trade” with Wal-Mart (WMT)

[stextbox id=”info”]Please keep in mind that these “10% Trade” alerts are for information purposes only. We’re not registered financial advisors and these aren’t specific trade recommendations for you as an individual. Each of our readers have different financial situations, risk tolerance, goals, time frames, etc. The ideas we publish are simply ideas that we feel fit our specific needs and that we’re personally making in our own portfolios. You should also be aware that some of the trade details (specifically stock prices and options premiums) are certain to change from the time we make our trade to the time you’re alerted about it. So please don’t attempt to make this “10% Trade” yourself without first doing your own due diligence and research.[/stextbox]

By its very nature a “10% Trade” is designed to generate income.

You make the trade, collect the income, and then rinse and repeat every six to 10 weeks.

Add it all up and you’re looking at potentially capturing 10%-plus yields from world class stocks like Wal-Mart (WMT), McDonald’s (MCD), Coca-Cola (KO) and more.

That’s the idea anyway.

The problem is, depending on which account you’re making your “10% Trades” in, you may have to pay taxes on all the income you’re generating.

[hana-code-insert name=’adsense-article’ /]While this can be a good problem to have — because it means you’re making money — the taxes eat directly into your profits and the paperwork can be a headache.

But there may be a better way to make a “10% Trade”… and not only does it allow you to bypass the tax paperwork, but you can actually avoid the taxes themselves as well.

I’m talking about making your “10% Trades” in an after-tax account like a Roth IRA.

I’ll explain…

I currently own 17 individual stocks in my Roth IRA… and each and every year these stocks are delivering more and more income, which allows me to buy more and more shares (which in turn, generates more and more income).

The beauty is, when it comes time to withdraw from this account — I’m eligible in as early as 25 years from now — I won’t have to pay any taxes on this income.

That’s precisely why I want to accumulate as many shares of high-quality dividend growth stocks as I can in this account. And the sooner the better in order to let the wonders of compounding take place.

Thing is, if I want more shares than what the dividends alone can purchase, then I need to get extra cash in that account somehow.

That can be a problem.

You see, Roth IRAs have strict annual contribution limits. You can’t just add whatever you want to these accounts. In fact, depending on your level of income, you may not even be able to contribute anything new at all.

But that’s where a carefully selected “10% Trade” can come in handy…

Remember, by its very nature a “10% Trade” is designed to generate income. And if used properly, it can essentially be a “back door” way of contributing more to your Roth IRA than what you’re eligible to contribute.

At the end of the day, this could translate into significantly more tax-free income when it comes time to withdraw.

Consider the “10% Trade” I made with Wal-Mart (WMT) yesterday in my Roth IRA…

“Back Door” Way to Contribute More to Your Roth IRA
While I’m no longer eligible to make contributions to my Roth IRA, my “10% Trade” put an instant $82.00 in my account yesterday, legally (not counting any commissions).

In addition, I’ll be adding another $48.00 to my account when Wal-Mart pays its next dividend on April 1, 2014.

After that, depending on how the “10% Trade” works out, I may be able to repeat this process over and over again… essentially “contributing” more and more funds to an account in which I’m no longer eligible to make contributions to.

Or, come April 19, I may sell my Wal-Mart shares at a profit… which will add another $274.00 to my account in the form of capital gains.

Not counting any commissions in these numbers, either way the “10% Trade” works out I’ll have contributed an extra $130 to $404 to my Roth IRA… even though the IRS says I can’t.

Keep in mind this extra “contribution” is possible thanks to just one single “10% Trade” that closes out on April 19 — less than two months away. Imagine how much income you could generate by executing these kinds of trades over and over again across your entire portfolio, for years (or even decades) to come.

Then imagine, when the time comes, that you’ll be able to withdraw all this income tax-free.

That’s the power of making a “10% Trade” in an after-tax account like a Roth IRA.

Here’s a breakdown of the specific “10% Trade” I made with Wal-Mart yesterday. Hopefully this gives you a better idea of how it all works…

Capturing a 10.4% to 32.5% Annualized Yield from Wal-Mart
Before making my “10% Trade” yesterday I was already holding 100 shares of Wal-Mart (WMT) in my Roth IRA at a cost basis of $72.26 per share. Yesterday, I sold one April 19, $75 covered call for $0.82 per share.

There are only two possible ways this trade will work out… and the result should be at least a 10% annualized yield either way.

Scenario #1: Wal-Mart stays under $75 by April 19
If Wal-Mart shares stay under $75 by April 19 I’ll get to keep my 100 shares.

"10% Trade" with Wal-MartI’ll also have received $82 in covered call income ($0.82 x 100 shares) and $48 in quarterly dividends ($0.48 x 100 shares).

The covered call income — known as a “premium” in options speak — was collected instantly yesterday.

I’ll collect the dividend income with Wal-Mart’s upcoming dividend payment.

At the end of the day, if this scenario plays out I’ll be looking at a $130 profit before commissions.

That may not sound like a heck of a lot, but take a look at the percentages: I received an instant 1.1% yield for selling the covered call ($0.82 / $72.26) and I’ll get a 0.7% yield from the upcoming dividend ($0.48 / $72.26).

When I subtract out the commissions I’m looking at a 1.7% return in 58 days… which works out to a 10.4% annualized yield, from a safe stock like Wal-Mart. And again, tax-free.

Scenario #2: Wal-Mart climbs over $75 by April 19
"10% Trade" with Wal-MartIf Wal-Mart climbs over $75 by April 19 my 100 shares will get sold (“called away”) at $75 per share.

In this scenario, not only will I get to keep the $82 in covered call income ($0.82 x 100 shares) and the $48 in quarterly dividends ($0.48 x 100 shares)… but I’ll also generate $274 in capital gains ($75 – $72.26 x 100 shares) in the process.

In this scenario, before commissions I’ll be looking at a $404 profit.

From a percentage standpoint, this “10% Trade” will deliver an instant 1.1% yield for selling the covered calls ($0.82 / $72.26)… a 0.7% yield from the upcoming dividend ($0.48 / $72.26)… and a 3.8% return from capital gains ($75 / $72.26).

After subtracting out the commissions, I’m looking at a 5.2% total return in 58 days (two months).

That works out to a 32.5% annualized yield from Wal-Mart.

Bottom Line: Either way this “10% Trade” works out offers me the opportunity to generate a 10%-plus annualized yield from my shares of Wal-Mart (WMT)tax-free. If I get to keep my shares, compound my income, and “rinse and repeat” this process to continue lowering my cost basis, great. Or, if I’m forced to sell Wal-Mart at a 32.4% annualized profit, no problem. This is why I’m such a fan of “10% Trades”… especially when I can make them in an after-tax account like a Roth IRA.

Greg Patrick

P.S. I realize the average financial advisor may think it’s crazy to trade individual stocks in a retirement account… no matter how safe the stocks appear. And in many cases they’re probably right — especially if you’re not properly diversified and you’re heavily dependent on the income from this account. So I urge you not to blindly follow my lead today without first speaking to a professional advisor or doing your own due diligence and research.

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