An Income Strategy with Options – Part I

As professional investors managing money for institutions, we had some early mentors, but most of what we learned was learned on the job. I was only 29 when we launched our first standalone hedge fund strategy, so I had only a brief time in my career to learn from my elders.

My entry into the newsletter business was the exact opposite!

That part of my career started when I had already been a professional investor for over two and half decades, but I had the opportunity to join a team full of Hall of Famers.

As many of you know – my career in the newsletter business began with my old friend Whitney Tilson at Empire Financial.

Empire was part of the organization started by Porter Stansberry. To me, Porter is the Babe Ruth, Lou Gehrig, and Joe DiMaggio of the industry all rolled up into one. In one 30-minute conversation with him, I learned more about the industry than in one hundred hours of conversations with many others.

There was another team member there, though, who also belongs in the Hall of Fame. His name is Dr. David Eifrig, or as he is affectionately called, "Doc.”

Doc has one of the most unique careers of anyone out there. After working on Wall Street for many years, he became a medical doctor and eventually came to Stansberry Research to launch his franchise. You can read about his career here.

When we joined Empire, one of the first things we heard about was an incredible track record that Doc had put together in one of his publications. Making money in 90%+ of his positions. Sometimes, with winning streaks that went on for YEARS!

We dug into those strategies, and we were impressed.

Doc has figured out how to use options so investors can generate steady income while taking minimal risks.

You can learn more about Doc's strategy in this free demo video.

Over the next two days, we will share two of his strategies and how you can take advantage of them.

The first of these is selling a “covered call.”

Many of you may have used this strategy in the past, but we will go through a full definition of what this means for the benefit of those who have never done it.

When you BUY a “call option,” you have the right – but not the obligation to buy a stock at a specific price (called the "strike price") by a particular time (called the "expiry date").

We will use a real-world example with the most popular stock in the world right now – NVIDIA Corporation (NASDAQ: NVDA).

Right now (after the split), the stock is trading at roughly $130 per share.

Here is a chart of the stock price…

We can see that the options expiring on July 19, 2024, with a strike price of $140, are trading at roughly $4.35 per contract.

A contract represents 100 shares, so buying a single contract would cost you $435 in this instance.

There are two values to an option.

The first is the difference between the strike and current share prices. With the stock trading at $130 and the call option representing the right (but not the obligation) to buy the stock at $140 – this value is $0. This particular option is "out-of-the-money" by -$10, so it has no "intrinsic value."

Then why is it still selling for $435?

The reason is the "time value." This value exists because we still have a month before the option expires.

That value (100% of the value of this particular option) is what call buyers are willing to pay for the “chance” that the stock trades above $140 per share.

In this case, the stock would have to trade above $144.35 for an investor to make money on the stock. That is about +10% from here.

This kind of move in a month would seem unlikely for many stocks, but with NVDA, everything is on the table.

Still – paying $435 for an option that is 10% out-of-the-money in just a month is a rich premium.

We don't have a formal recommendation on NVDA stock, but we think it is technically extended. The last time the stock was extended (early March), the stock then consolidated (and moved lower) for two months.

This is where the “covered call” becomes an opportunity!

A “covered call” is when you sell a call against stock that you ALREADY OWN.

When you SELL an option, you are obligated to sell the stock at the strike price by the expiry date.

In this case with NVDA - IF you owned 100 shares of the stock, you could sell this same contract and bring in $435 of income.

Why would you do this?

If you agree with our short-term technical view, you might think the stock will not go much higher. Or that it may even go lower.

You may also, however, not want to sell the stock.

By SELLING the call option and creating a "covered call" position, you get PAID the same $435 we mentioned above.

It also decreases your adjusted stock price by the same $4.35 per share. This means you would still be profitable on the combined call and stock down to a share price of $135.65. This is a nice little cushion underneath.

In fact – even if the stock rallies but doesn't finish above $140 by the expiry date (July 19), you get to keep the $4.35 per share or $435 of income.

The only way that you "lose" is if the stock goes above $140, particularly above $144.35 – the combination of the strike price plus the premium you were paid.

Should you make this trade?

It depends on many factors, but this is an excellent example of a covered call income strategy.

One reason you would not do it is because you think NVDA will be much higher than $144.35 in the next month. That is a valid view, and this strategy wouldn’t make sense.

Another reason might be your tax situation. You may have a very low tax basis in the stock or other tax situations where you don't want to generate the taxable gains that would occur if you were to sell the stock to cover the call.

If, however, you don't think the stock goes that high or taxes are less of an issue, this is a nice way to generate some income from a position you already hold.

Doing this correctly over time is a great way to take advantage of the "hype," protect your investment, and generate some incremental income.

Remember, this is ONLY when you own the stock.

We would NOT recommend selling "naked calls" almost ever, and certainly not in a stock like NVDA. Your risk is unlimited!

If done correctly, this is an awesome strategy to increase your returns, reduce your risk, and generate some REAL income.

Have you ever sold “covered calls” against your long stock holdings? What was your experience? Tell us more in the comments section below or at [email protected]

Check out Enrique Abeyta’s conversation with Mo Al Adham on the latest HX Podcast episode, or watch on YouTube below.

In this episode, we get a full primer on the concept of "direct indexing".  Regular listeners will recall Howard Lindzon mentioning this tax-saving idea last month.  We needed to know more!

On Howard’s advice, Enrique got in contact with Mo Al Adham.  His company Frec deals exclusively in direct indexing, an investment strategy that tracks the performance of indices like the S&P 500 while harvesting losses that can offset capital gains taxes.  He explains how it works, who it works for, who's doing it, and for how much!