How To Turn Losing Stocks Into Winning Trades
Have you ever been stuck in a losing investment that just keeps trading the wrong way?
I wish I could say that I’ve never been there. But the truth is, if you’re a serious investor, there is bound to be a time when one or more of the stocks your invested in trades lower. That’s just the nature of markets!
Below is a snapshot I took of my desk today. Do you see what’s missing?
That’s right! There’s no crystal ball…
Sure, I subscribe to a variety of excellent research services. And I spend a lot of time researching the investments I make in my family’s account and the investments I recommend to subscribers.
But no matter how much due diligence I put into my trade decisions, there are bound to be times when trades just don’t work out as planned.
Thankfully, there’s a special investment strategy I use to continually tilt the odds of success in my favor. In fact, this strategy often lets me turn losing stocks into winning trades.
It’s a strategy I’ve taught thousands of subscribers to use. And it’s one of the ways that I’m able to continually grow my family’s wealth. Let’s take a look!
The Advantage of Covered Calls
The “covered call” strategy is one of the most powerful income-generating investment strategies available to investors. Here’s how it works.
Suppose you invest in a stock such as General Electric (GE). Shares of GE are currently trading near $28.30 as I write. The stock pays a quarterly dividend of 23 cents per share, good for an annualized yield near 3.25%
Traditional investors will simply hold shares of GE, collect their quarterly dividend checks, and hope that shares trade higher. But with our covered call strategy, we can actually collect extra income payments from our shares of stock.
To collect these income payments, simply sell call contracts for your shares of GE. (There are call contracts available for just about any liquid stock that trades on US public markets.)
When you sell a call contract, you’re simply entering an agreement. You don’t need to own a call contract to sell one. The act of “selling” is essentially accepting the terms of the call contract agreement.
By selling a call contract, you’re agreeing to sell your shares of stock at a particular price. The investor who bought the call contract gets to choose whether to “exercise” this agreement or not (within a specific time period).
In our example, you might consider selling the January 2017 $29 call contract. By selling this contract, you’d be agreeing to sell your shares at $29, sometime between now and the third week in January. You would get paid roughy 60 cents per share to enter this agreement – or nearly three times the quarterly dividend for GE.
By selling call contracts for your stocks, you can continually collect extra income. And that income can come in handy if your shares wind up trading lower.
Our Stock Traded Lower, Yet Our Trade Turned a Profit!
To illustrate how effective this strategy can be, I thought I would use a real-world example sent to me by one of my Income on Demand subscribers. Jeff W. sent me a table with his recent trades for Sears Holdings (SHLD). Sears is one of those stocks that has been trading lower. However, our income from selling call contracts has more than offset the pullback in SHLD shares.
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Jeff started by selling put contracts on SHLD. (When we sell a put contract, we’re getting paid to agree to buy shares of stock at a certain price. It’s a great way to buy shares of great stocks at a discount).
When SHLD pulled back, Jeff’s puts were exercised. That means he was required to buy shares of SHLD at his agreed upon price of $13.00. Here’s what his trade looked like at that point.
Selling Calls For Additional Income…
As you can see, Jeff received $122 from selling his put contracts, and then paid $2,602 to buy shares of SHLD. Between the two transactions, his net cost for his SHLD shares was $12.40.
Now Jeff’s next step was to sell call contracts for his SHLD shares. Jeff followed my recommendation to sell October $12 calls. This meant that Jeff was agreeing to sell his shares at $12. And Jeff received an additional $118 from selling these calls.
After selling the call contracts and receiving the additional $118 in income, Jeff’s total cost basis was reduced to $11.81 per share. So even though shares of SHLD were trading lower, Jeff’s total costs for his shares was also moving lower. This is how we’re able to offset a pullback in shares that we own.
SHLD was trading below $12 when the October calls expired. That meant Jeff did not wind up selling his shares at $12. This gave us another chance to sell more call contracts and collect even more income. Once again, Jeff followed my recommendation and sold November $11 call contracts.
This time, Jeff received an additional $178 from selling his call contracts.
Now it appears that in two weeks, Jeff will sell his shares of SHLD at $11, a full two dollars below his original $13 purchase price. But thanks to the income from selling put and call contracts, Jeff will actually turn a small profit on this trade!
No Such Thing as a “Free Lunch”
One of the things that I learned early in my investment career is that there are very few instances where investors get a special benefit without giving up something in return. In other words, “there’s no such thing as a free lunch!”
While it may sound like our covered call strategy gives us “free” income from our shares, it’s important to understand what you’re giving up in return for this income.
When you sell a call contract for shares of stock that you own, you’re agreeing to sell your shares at a particular price. You must keep this agreement regardless of how high these shares trade.
So in the example above, if SHLD were to announce strong earnings and the stock were to trade up to $15, Jeff would still be required to sell his shares at $11. That’s because Jeff sold the SHLD November $11 calls — thereby entering an agreement to sell his SHLD shares at $11.
Now I believe that the covered call tradeoff is a good one for most investors. It has certainly given my family a lot of extra income that we would not have otherwise received.
Selling calls for shares of stock that you own is a great conservative strategy that helps protect your wealth and generate extra income. But it’s not a “get rich quick” trading approach.
As a general rule, conservative cash-flow positive income strategies will help you accumulate wealth much more reliably than speculative trading approaches. So make sure you weigh these two approaches to investing next time you decide whether to take a flyer on a stock tip, or embrace this more reliable income strategy.
Here’s to growing your income!