By its very nature a “10% Trade” is designed to help you generate extra income.
As a refresher, a “10% Trade” is a conservative income-oriented trade that involves selling either a covered call or a cash-secured put on a reasonably-priced, high-quality dividend growth stock.
You make the trade, collect the income, and then rinse and repeat — typically every six to 10 weeks.
Add it all up and you’re looking at potentially capturing 10%-plus annualized 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 currently own several core dividend growth stocks in my Roth IRA, such as Apple (AAPL), Cisco (CSCO), Disney (DIS), Hershey (HSY), Johnson & Johnson (JNJ), Coca-Cola (KO), Microsoft (MSFT), Target (TGT), Wells Fargo (WFC), Wal-Mart (WMT) and Exxon-Mobil (XOM). 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 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 on Friday with Tiffany & Co. (TIF), a high-quality dividend grower that appears to be significantly undervalued…
“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 $384.00 in my account Friday, 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 49 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. Here are the specific details of my trade…
Opportunity to Capture a 22.0% to 41.6% Annualized Yield from TIF
On Friday I bought 200 shares of TIF for $63.30 per share and simultaneously “sold to open” two September 19, $65.00 covered calls for $1.92 per share.
With this in mind, there are likely two ways this trade will work out — and they both spell at least double-digit annualized yields on my purchase price…
Scenario #1: TIF stays under $65.00 by September 19
If TIF stays under $65.00 by September 19, I’ll get to keep my 200 shares.
In the process I’ll also have received $384.00 in covered call income ($1.92 x 200 shares).
The covered call income — known as a “premium” in the options world — was collected instantly on Friday. It was deposited in the account where I made the trade, which is my Roth IRA.
At the end of the day, if “Scenario 1” plays out I’ll be looking at $374.46 in profit after commissions and fees.
On a percentage basis, I received an instant 3.0% yield for selling the covered calls ($1.92 / $63.30).
When I subtract out the commissions and fees I’m looking at a 3.0% yield in 49 days, which works out to a 22.0% annualized yield.
Scenario #2: TIF climbs over $65.00 by September 19
If TIF climbs over $65.00 by September 19 my 200 shares will get sold (“called away”) at $65.00 per share.
Like “Scenario 1”, I get to keep the $384 in covered call income ($1.92 x 200 shares)… but I’ll also generate $340 in capital gains ($1.70 X 200).
In this scenario, after commissions and fees I’ll be looking at a $706.27 profit.
From a percentage standpoint, this “10% Trade” will deliver an instant 3.0% yield for selling the covered call ($1.92 / $63.30) and a 2.7% return from capital gains ($1.70 / $63.30).
After subtracting out the commissions and fees, I’m looking at a 5.6% total return in 49 days.
That works out to a 41.6% annualized yield from TIF. Not bad, considering the stock’s “regular” yield is 2.8%.
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.[hana-code-insert name=’MMPress’ /]