I Just Made This Tax-Free “10% Trade” with Coca-Cola (KO)

[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 extra income from high-quality dividend growth stocks.

You make the trade, collect the income, and then rinse and repeat — typically every six to 10 weeks. Sometimes longer, sometimes shorter.

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)Apple (AAPL)IBM (IBM)Microsoft (MSFT)Pepsi (PEP) 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 several core dividend growth 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 24.5 years from now — I won’t have to pay any federal 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 Coca-Cola (KO) yesterday in my Roth IRA…

“Back Door” Way to Contribute More to Your Roth IRA
While I’m not eligible to make any additional contributions to my Roth IRA, my “10% Trade” put an instant $204.00 in my account yesterday, legally (not counting any commissions).

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.

Keep in mind this extra “contribution” is possible thanks to just one single “10% Trade” that lasts just 31 days. 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.

An Opportunity with Coca-Cola
I had actually been on the lookout for another potential “10% Trade” with Coca-Cola ever since my last KO trade closed out back on April 19.

Even though the stock is up since my trade closed, thanks to the recent sell-off, Coke really hasn’t gone anywhere year-to-date. It’s up about a half percent as I write…

Coca-Cola (KO)

If you’re interested in picking up some shares of Coke at current prices, one obvious option is to just buy shares outright at the market price.

Another option — one that adds a level of safety — is to make a “10% Trade” and get paid immediately for simply agreeing to buy shares today and then sell them at a  higher price in the future.

Since I’m looking to safely “contribute” extra income to my Roth IRA, I chose the second option yesterday. Below are the details of the specific “10% Trade” I made.

In short, it should generate a 17.8% to 18.6% annualized yield. Here’s how…

Opportunity to Capture an 17.8% to 18.6% Annualized Yield from Coca-Cola
Yesterday I bought 300 shares of KO for $40.94 per share. I then “sold to open” three November 22, $41 covered calls for $0.68 per share.

There are two possible ways this trade will work out — and they both spell at least double-digit annualized yields on my purchase price…

"10% Trade" with Coca-Cola (KO)

Scenario #1: Coca-Cola stays under $41 by November 22
If Coca-Cola stays under $41 by November 22 I’ll get to keep my 300 shares.

In the process I’ll also have received $204.00 in covered call income ($0.68 x 300 shares).

The covered call income — known as a “premium” in options speak — was collected instantly yesterday. It was deposited in my Roth IRA.

At the end of the day, if “Scenario 1” plays out I’ll be looking at $185.10 in profit after commissions.

On a percentage basis, I received an instant 1.7% yield for selling the covered calls ($0.68 / $40.94).

When I subtract out the commissions I’m looking at a 1.5% yield in 31 days… which works out to a 17.8% annualized yield.

[hana-code-insert name=’adsense-article’ /]Scenario #2: Coca-Cola climbs over $41 by November 22
If Coca-Cola climbs over $41 by November 22 my 300 shares will get sold (“called away”) at $41 per share.

In “Scenario 2” — like “Scenario 1” — I get to keep the $204 in covered call income ($0.68 x 300 shares). I’ll also generate $18.00 in capital gains ($0.06 X 300).

In this scenario, after commissions I’ll be looking at a $194.40 profit.

From a percentage standpoint, this “10% Trade” will deliver and instant 1.7% yield for selling the covered calls ($0.68 / $40.94) and a 0.1% return from capital gains ($0.06 / $40.94).

After subtracting out the commissions, I’m looking at a 1.6% total return in just 31 days.

That works out to an 18.6% annualized yield from Coca-Cola.

As I said yesterday, as long as the market continues to offer safe, income-generating opportunities like this one, I’ll be more than happy to take them. Especially if they give me a “backdoor” way to contribute extra cash to my Roth IRA.

Greg Patrick

P.S. I realize the typical financial advisor may think it’s crazy to trade individual stocks in a retirement account… no matter how safe the stocks may 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. In addition, I’m not a tax advisor and I don’t claim to be… so please consult a professional for any tax related questions you have.

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