Video #2 in our 4-part series, featuring Bryan Perry, Investing in LEAPS (Long-term Options) for Short-term Income.
VIDEO #2 TRANSCRIPT:
Roger: Hi, this is Roger Michalski, publisher of Eagle Financial Publications. This is video two of our series with Bryan Perry, editor of Cash Machine, and a leading expert on income investing.
Bryan, in video one, we talked about LEAPS and all the great advantages of LEAPS, how you can own a stock that’s maybe $700 for a fraction of the cost – the big name stocks like Google, Facebook, Amazon. Those are the things that people want to buy and have in their portfolios, but it’s hard when it’s $700 a share. So, we went over all the benefits of that, which are incredible.
However, you have another strategy where you can get instant income on these LEAPS as well, so tell us about that strategy.
Bryan: Well, that’s true, Roger, we want to really target our income while the ins here that is looking to cultivate really outsized returns from using the biggest name stocks. And, because a lot of the big name stocks don’t pay big, hefty-weighted dividends, there’s a way we can garner a tremendous amount of income from these names by utilizing what is called a Bull Call Spread.
It sounds sophisticated, but it’s a very simple strategy. Simply, we’re buying the long-term LEAP that goes out into 2017 and further out – maybe 2018 – and, what we’re doing at that same time, we’re selling an out-of-the-money short-term call against the long-term leap.
So, as we mentioned in the first video, 90% of all short-term call options expire worthless, because people are greedy. Their emotions make them buy short-term calls that expire in the next few weeks or the next month or so. And they typically go too far out-of-the-money for the option to be worth anything, because they’re expecting the stock to make a big move in a short period of time. Hence, why they want to buy a lot of contracts. Basically, their emotion to make money in the short-term overrides what is – I call – good discipline. That’s the problem with most option traders.
To our advantage, we want to be able to sell that greed right back at them. We want to be on the other side of that tree. That’s really the beauty of selling short-term covered calls. So, by buying the in-the-money LEAP, we buy into what is called the delta, which we talked about in the first video too. We want to buy something that’s going to move point for point with the stock on the way up.
If the underlying security is Facebook, for instance, at $120 a share, we want to buy a LEAP that is going to be well-correlated with the stock. At the same time, we’re going to want to sell the Facebook $125 or $130 call over the short-terms, over the course of the next month, month and a half, two months out.
In doing so, we capture that premium. That’s free money; that hits our account immediately; that is instant income. From there, we might even get more appreciation out of the stock. If we get called out of the stock, we exercise the LEAP and we keep the premium, and it’s a magnificent return at that point.
What we’re trying to do is buy these stock that are on these very strong bull trends, whether that’s Facebook, Lockheed Martin, McDonalds, Home Depot, Costco, things like this – big tech names we spoke of. We want to be able to follow those stocks by buying the LEAPs and selling the short-term covered calls against them all year long. Typically, if it’s well positioned and well executed, you should be able to sell somewhere between five and six different covered strikes every year on each position. Once you do the math on that, it gets pretty exciting, so we’ll get into that in the next video when we’ll talk through some real examples.
That’s really the nature of the strategy – it’s to buy the long-term call, and the money in the call, and then sell the short-term out-of-the-money calls against it, That’s called a Bull Call Spread – very effective – professionals have been using it for a long time. And now it’s available to the average investor, because universal LEAPS has really taken off and it has become a liquid and attractive market.
Roger: It’s a great long-term strategy and a great short-term strategy to get instant income into your account. It sounds almost too good to be true, but we’re going to walk through an example in the next video, and you’ll see exactly how simple it is and how effective it is. So, we’ll see you in the next video.