Did you know you can collect income for simply agreeing to buy some of your favorite stocks for cheaper than what they’re selling for today?
If you’re already interested in owning these stocks at current prices, then the strategy I’m talking about is practically a no-brainer.
In short, it offers you a chance to safely boost your income stream while waiting to buy shares of your favorite stocks at a discount. Add up all the income, and we’re talking about the opportunity to safely generate 10%-plus yields.
The strategy that makes this all possible is called a “10% Trade.”[hana-code-insert name=’adsense-article’ /]A “10% Trade” is a term that my colleague Phil Lamanna and I use to refer to selling covered calls and cash-secured puts on high-quality dividend growth stocks that are trading at reasonable prices.
If you’re not already familiar with this strategy, it may sound complicated. But it’s not at all. And you owe it to yourself to learn how it works.
Here’s the big picture…
When you sell a covered call, you can get paid to sell your shares at a higher price than what you bought them for. When you sell a cash-secured put, you can get paid to buy shares at a discount to what they’re currently trading for.
Applying either of these two methods to a high-quality dividend growth stock that you’re already interested in owning (or one that you’re willing to let go at the right price) could be the single best way to safely generate 10%-plus yields from your portfolio over the next 12 months.
It’s for this reason I’ve been making “10% Trades” in my own personal accounts — in my brokerage accounts, in my Roth IRA, and in my Individual 401(k).
And it’s for this reason I’ve been sharing many of these real-life, real-money trades here at Trades Of The Day. I want you to see for yourself how it all works.
With all of this in mind, thanks to its recent sell-off, I’m getting very interested in making a “10% Trade” with International Business Machines (IBM).
In short, we’re looking at an opportunity to collect double-digit annualized income while we wait to buy this already-discounted stock for even cheaper.
Here’s what I’m talking about…
As I write, IBM is selling for $162.08 per share and the November 7, $160.00 puts are going for about $2.00 per share.
For the sake of simplicity, let’s say our “10% Trade” involves selling one of these puts. We’ll also exclude any trade commissions to help keep the math easy.
In short, there would only be two ways this trade could work out.
On one hand, we’d get to generate a 41.5% annualized yield from IBM without even owning the stock.
On the other hand, we’d get paid $200 in cash, immediately, for the opportunity to buy IBM at $160.00 per share (which is a 1.3% discount to what it’s currently selling for).
If you like safe double-digit income and the shot to own IBM at a discount to its already-depressed current price, then both of these options should be more compelling than simply buying the stock at the current market price.
Let’s take a closer look at each scenario…
Scenario 1: IBM falls below $160.00 by November 7
If IBM falls below $160.00 by November 7, we’ll be obligated to buy 100 shares at $160.00 per share. So we’ll need to set aside $16,000 for this trade.
In exchange for our agreement, we would be paid an instant $200 (100 shares X $2.00 per share).
This money would be deposited into our accounts immediately.
Taking this income into consideration, our cost-basis would drop to $158.00 per share ($160.00 – $2.00).
That’s a 2.5% discount to the $162.08 share price that IBM is selling for as I write.
Considering how the stock has already pulled back roughly 17% since mid-September, the opportunity to buy shares at an ADDITIONAL 2.5% discount from here is compelling. While shares could certainly continue to fall from here, we’ll rest assured knowing that we’re not buying at the top.
Scenario 2: IBM stays above $160.00 by November 7
If IBM stays above $160.00 by November 7, our put option contract will expire worthless and we won’t buy the stock.
However, we’ll have kept the $200 in income.
Taking that income into account, this works out to a 1.3% return on what our purchase obligation would have been ($2.00 / $160.00) in 11 days.
If we can repeat these results over the period of a year we could generate a 41.5% yield from IBM without even buying shares.
Like this setup? Here’s how we’d make the trade…
Sell to Open the November 7, $160.00 cash-secured puts on International Business Machines (IBM). Set a limit price of $2.00. Since each option contract involves 100 shares, we’ll need to set aside $16,000 for every contract we sell. The trade lasts 11 days and offers us an opportunity to 1) capture a 41.5% annualized yield without even owning the stock, or 2) own shares at a cost-basis of $158.00 per share (which is about 2.5% below today’s prices).
Potential Risks: When selling a put, the price of our underlying stock could drop below our cost-basis by expiration. If this happens, we’ll be obligated to buy shares at a price that is higher than what they’re trading for at the time we buy them. This is why we should ONLY consider selling a put on a stock we’d be happy owning at the strike price. It’s for this reason that I personally only make “10% Trades” with high-quality dividend growth stocks that appear to be trading at reasonable prices.
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