The idea here is to combine two very conservative strategies, covered call writing and married puts on dividend paying stocks. Both strategies can be utilized in a self-directed IRA fund, which will benefit from the tax-deferred nature of the account type. The idea with combining both the married puts strategy as describe in the previous post and covered call writing strategy that will be described in this post is the low risk nature of a married put on a dividend paying stock and the monthly/bi-monthly income generated by selling calls against the shares held in the portfolio.
In the previous example, I described a purchase of 100 shares of Altria Group (MO) at $88.00 and combining that with one January 2009 $90 Put Option at $8.80 with a total cost of $9,640. With this current setup the investor is protected to the downside by the dividends received on the 100 shares of Altria and can participate in the upside. Since we are currently long 100 shares of Altria Group, we can now sell one Altria Call option. For this example I will go four months into the future and select the June 2007 $95 Call Option which is currently trading at $1.40. This would result in a net increase in cash of $140 immediately since you sold the call option.
It is difficult to value the options in this example due to the differences in time frames and reactions to stock price changes. However, we can make assumptions and map out this transaction.
For example:
Ex 1. Stock price is less than $95 by June 2007 - +$140
Ex 2. Stock price is equal to $95 by June 2007 - +$140
Ex 3. Stock price is greater than $95 by June 2007 - +$140 - Increase over strike price
Example: $100 stock price would equal to a $500 loss on the options, but the 100 shares of long stock also increased by $500, plus the $140 premium received= +$140
To keep the short call option from being exercised if it is In-The-Money (in Ex 3.) the investor would need to buy back the option.
The idea here is to create a steady stream of income. Since the Dividend and Married Put strategy obligate us to hold our shares for 2 years, we can perform the above covered call strategy 6 times (24 months / 4 months). At the end of the 2 year holding period, assuming that a similar premium can be received each time, a total of $840 can be received over the two years.
Here is what the returns would now look like at the end of the two year holding period, assuming that the stock was not called away by a short In-The-Money Call option being exercised.
$90 or Below - +$884 or a return of 9.2% (4.6%)
$95 - +$1,388 or a return of 14.4% (7.2%)
$100 - +$1,888 ora return of 19.6% (9.8%)
$105 - +$2,388 or a return of 24.8% (12.4%)
However this is an oversimplified variation of the strategy because the value of the call and put options at the end of the four months is very difficult to calculate. Remember that these are two year numbers and returns, the annualized returns appear in the parentheses next to the total return. The stock market to many seems to be an uncontrollable beast, but with applying two conservative strategies, low-risk above average returns can be achieved.
These calculations do not take into account commissions and taxes.
