This Secret Transaction Gives You Cash From Your Favorite Tech Stocks
Last week, the Nasdaq Composite hit a new all-time high. The action was fueled by a strong rebound in some of America’s most popular tech stocks.
The stock market gains have been extremely impressive. Especially considering the huge challenges the global economy is facing as a result of coronavirus.
But even as these impressive gains roll in, I’ve heard from many of you who are frustrated with which stocks are leading the charge!
Since many of us here at The Daily Edge focus on income for retirement, there is some disappointment that the market is being led by tech stocks that typically don’t pay dividends.
That’s why today, I want to explain one little known strategy that can actually allow you to collect cash payments from your favorite tech stocks — regardless of whether they pay dividends or not.
Let’s take a look!
Locking in Payments From Shares of Stock
Back when I managed money for a $130 million hedge fund in Atlanta, one of my favorite strategies to safely grow our clients’ wealth was the “covered call” strategy.
Using this strategy, I was able to accelerate the normal gains that our clients received from their stock positions, by adding regular payments month after month.
These payments came from option contracts. But instead of buying options in a risky way like many amateur investors, I took the other side of the trade.
My strategy was to sell call contracts for the shares of stock that our customers owned. And by selling these contracts, our customers received thousands of extra dollars (and often tens of thousands of extra dollars) in their accounts each month.
The beauty of this strategy is that you don’t have to be a hedge fund manager to make it work. In fact, I know a lot of individual investors — including myself and some of my family members — who do this each month!
Here’s how this strategy works.
An Agreement to Sell Shares of Stock
Let’s say you own shares of Peloton Interactive (PTON). This is a popular fitness tech company that has been successful in growing during the coronavirus crisis.
PTON is a great American success story. But unfortunately, PTON doesn’t pay a dividend, so most investors won’t get any income from holding PTON shares.
Today, shares of PTON are trading near $46.
If you held shares that were currently priced at $46, would you make an agreement to sell your shares at $50? That sounds like a pretty good deal, right?
How about if someone paid you $2.50 per share in exchange for your agreement to sell at $50?
That’s an even better deal!
And that’s exactly how our covered call strategy works.
Right now, you can sell a call contract for PTON that causes you to enter an agreement to sell shares at $50. And you can get paid $2.50 for entering that agreement.
As its name implies, a call contract is simply a contract (or agreement) between two investors. You don’t technically have to own a call contract to sell it. Instead, when you “sell” a call contract, you’re simply entering an agreement to sell your shares of stock.
And the best part is that you get paid cash — which is immediately deposited in your brokerage account — to enter that agreement.
Let’s take a closer look at how these contracts are structured.
Call Contracts In Detail
Each call contract that trades in the market has a very standardized setup so it is easy for investors to buy and sell — knowing exactly what type of agreement they’re entering.
A call contract has a few key details you’ll want to be aware of.
Underlying Stock — We always start by looking at call contracts for specific stocks. For most popular stocks in the market, there are dozens of actively traded call contracts.
Expiration Date — Each call contract has a standard expiration date. This is the date on which the agreement is complete. The most popular call contracts expire on the third Friday of each month.
Strike Price — This is the agreement price — or the price that buyers and sellers are willing to pay and receive for the shares of stock. In our PTON example above, the strike price is $50.
Contract Size — Normally, each contract represents 100 shares. So if you’re selling one call contract, you’re agreeing to sell 100 shares of stock. Given this contract size, it’s typically easier for individual investors to use lower-priced stocks with this strategy so you don’t have to spend too much buying 100 shares of a high priced stock.
Now that you understand a bit more about how these contracts are structured, let’s take a look at how our income play could turn out.
Heads I Win, Tails I Still Win!
Let’s keep using the PTON example we started with. If you sold the July 17th $50 call contracts, you should have received about $2.50 per share for entering your agreement.
The agreement states that if the buyer of the call contract wants, he or she can buy 100 shares of PTON from you at $50 per share.
Now that buyer would only want to exercise his or her right to buy the shares if PTON is trading for more than $50. So there’s a chance you may not be required to sell your shares. But either way, you get to keep the $2.50 per share that you received.
On July 17, if shares of PTON are trading below $50, you’ll get to keep your shares of PTON, and the call contract will expire. That means the call contract will disappear from your account, and you’ll no longer have any obligation to sell your shares.
From there, you can enter a new call contract — possibly selling August or September call contracts. Can you see how this can be a very lucrative income strategy over time?
On the other hand, if PTON is trading above $50 when the call contracts expire on July 17, you’ll be required to sell your shares at $50.
You may be giving up some potential extra gain from your shares. But at the same time, you’re still selling the shares for more than they were worth when you sold your call contracts. Plus, you’re still able to keep the extra $2.50 per share of PTON that you received when you sold the call contracts.
So either way, this strategy helps you generate extra income from stocks that would not normally pay a dividend.
It’s a great way of profiting from today’s market and adding extra cash to your nest egg.
I’d love to hear what you think about this strategy — and please tell me if you’d like to hear about more hedge fund approaches like this that can help you get more income from the market.
Just drop me an email at EdgeFeedback@StPaulResearch.com.
Here’s to growing and protecting your wealth!