Yesterday, in my latest “high-yield trade”, I bought 100 shares of Lowe’s (LOW) for $74.43 per share and simultaneously “sold to open” one September 22 2017, $74.50 call option for $2.56 per share.
High-yield trading is a strategy designed to generate above average income from some of the best companies in the world.
In exchange for that opportunity, the buyer of the option paid me $2.56 per share (the “premium”).
Because I collected immediate income when the trade opened, I’m lowering my cost basis on the shares I’m buying.
This is precisely what makes a “high-yield trade” safer than simply purchasing shares of the underlying stock the “traditional” way.
Yes, I’m limiting my potential upside (if Lowe’s shares climb to $80, for example, I’ll still be forced to sell at “just” $74.50)… but that would still generate a small capital gain for me… AND I’m generating immediate income in the process.
It’s a trade-off… and one I’m willing to make because this strategy of selling a call option instead of buying one is designed to be conservative and to generate income. For this reason, it’s been called “the greatest income-producing tool for retirees.”
With all of this in mind, there are likely two ways this trade will work out — and they both spell high annualized yields on my purchase price…
Please note: To be conservative, I don’t include any dividends in my calculations for either of the following scenarios. Any dividends collected are just “bonus” that will boost the overall annualized yields even further.
Scenario #1: Lowe’s (LOW) stays under $74.50 by September 22
If LOW stays under $74.50 by September 22, I’ll get to keep my 100 shares.
In the process I’ll also have received $256 in call income ($2.56 x 100 shares).
The call income, or premium, was collected instantly yesterday. It was deposited in the account where I made the trade, which is my 401(k) retirement account.
At the end of the day, if “Scenario 1” plays out I’ll be looking at $250.35 in profit after commissions and fees.
On a percentage basis, I received a 3.4% yield for selling the call ($2.56 / $74.43).
When I subtract out the commissions and fees I’m looking at a 3.4% yield in 36 days, which works out to a 34.1% annualized yield.
Scenario #2: Lowe’s (LOW) climbs over $74.50 by September 22
If LOW climbs over $74.50 by September 22, my 100 shares will get sold (“called away”) at $74.50 per share.
Like “Scenario 1”, I get to keep the $256 in call income ($2.56 x 100 shares). But I’ll also generate $7 in capital gains ($0.07 x 100) since I bought at $74.43 and will be selling at $74.50.
In this scenario, after commissions and fees I’ll be looking at a $252.60 profit.
From a percentage standpoint, this high-yield trade will deliver an instant 3.4% yield for selling the call ($2.56 / $74.43) and a 0.1% gain ($0.07 / $74.43).
After subtracting out the commissions and fees, I’m looking at a 3.4% total return in 36 days.
That works out to a 34.4% annualized yield from Lowe’s. Not bad, considering the stock’s “regular” yield is just 2.2%.
P.S. I only made this trade because: 1) I want to own the underlying stock anyways 2) I believe it was trading at a reasonable price when I made the trade 3) I am comfortable owning it for the long-haul in case the price drops significantly below my cost basis by expiration and 4) I am comfortable letting it go if shares get called away. To be mindful of position sizing, except in rare cases, the value of this trade wouldn’t exceed 5% of my total portfolio value. In addition, to minimize taxes and tax paperwork, I made this trade in a retirement account.