The other day I was talking to a reader of my newsletter StocksTalk and this 50-something year old farmer told me he was going to retire because he had other things he could do with his time and money. He also said that he owed at least some of his financial success and his opportunities now to a farmer he worked for years ago. I will call this reader William.
William said, “That farmer told me not to put all of my money into my farm. So over the years my wife and I always put some money into stocks, bonds and guaranteed income certificates, and now at age 50 I have choices. I can keep on farming if I want to, or I can retire and do something else. As things stand now, it would be better for my health if I quit farming. So we’re going to have an auction sale.”
Then he added, “Andy, I suggest you tell your readers that they should set up their financial affairs now so they create opportunities for themselves later on in life.”
William also said he was going to sell covered calls part time on some stocks he already owned or would buy with some of his money, and he’d invest the rest of his money into treasury bills, GICs and guaranteed savings accounts. He’s learned how to sell covered calls by reading StocksTalk and by talking to me. So he only needs about $100,000 to $150,000 worth of decent stocks to make him around $30,000 to $40,000 a year working part time. And he could double that income if he needed or wanted to. He knows what to do and has the money to do it with.
You don’t need six figures in stocks to start selling covered calls. A person can start with $5,000 or $10,000 or $20,000 and learn how to make some good cash too so it’s not as if we have to be a big investor to sell covered calls. In my newsletter I explain how to use the Tax Free Savings Account (TFSA) to make some good money starting with $5,000.
I pondered on the headline for this article for some time. I did think of using the headline “Make a million bucks on the side” or “It’s quite easy to make $500 to $1000 a month,” but after I spoke with William, it seemed the right headline would use the word “opportunities.”
I know that a lot of farmers are hurting. That’s not to say farming was a bad career because it wasn’t. But after a lifetime of work, many cattle producers now are selling their herds at fire sale prices. Many grain farmers wonder if there is a crop they can grow in 2009 that will make them money. The farm policies in the United States that set up COOL (country-of-origin labelling) have killed a market for a lot of Canadian pork and beef. And Canadian farmers have not invested much time developing a market for their meat in China and Japan. Selling to the U. S. was just too easy, especially when the Canadian dollar was so low for so long.
And when I first wrote about learning how to make money with stocks, and how to sell covered calls, many farmers just remembered how stocks dropped in price now and then and forgot how the price of their cows has dropped from $1,200 to $600 to $300 over the past six years. And they don’t seem to remember that for years crops paid less than the cost of growing them. And many farmers would not have survived without the industry where people make a career of lobbying governments for money.
In fact, one reader took me to task when I wrote about selling covered calls because it would limit gains. When cows were $1,200 I suggested that it might be a good idea to sell some cows and buy some shares in Microsoft and a reader sent me about 150 pages of stuff about why Microsoft was dead in the water.
Now please don’t get the idea that I’m saying I told you so. Because I’m not. I have written about the five-legged stool many times since 1993 when I thought out that idea because I thought it was a good overall financial strategy and I have used it myself. One leg is to learn how to make money with stocks. You see, while stocks do have bull and bear markets, they also have reversible decisions. While one farm policy like COOL has damaged or ruined the Canadian meat industry, and ruined many Canadian farmers, it’s pretty well impossible for a government to damage the business of stocks.
In fact, stocks are such a big part of pension funds, insurance companies and other investment plans that governments actually try to protect or at least not destroy values and they like to tax the profits.
SELLING COVERED CALLS
Here’s one example of what I’ve seen with a good stock and selling covered calls. Take shares in Bank of Nova Scotia (BNS). (Any Canadian bank would do.) They have been called widow and orphan stocks because they pay a nice dividend, the company raises the dividend almost every year, the management grows the company around the world and the price was $11 in January 2000, adjusted for a two-for-one split since then. Now the price is $39 to $40.
In the past three years, BNS share prices went down and up but they have paid a dividend that has come up to $2 per share. So let’s say those 3,000 shares have made the shareholder $6 per share or $18,000 over three years.
I know that a person could have sold covered calls on BNS pretty well every month these past three years, which would have created income 36 times. The cover call premium has been a pretty easy $1 a month, so do the math: $1 multiplied by 36 months by 3,000 shares equals $108,000 in cash over the three years. Add the $18,000 in dividends, and you get $126,000. That’s $42,000 per year on an investment of say $120,000. Most people don’t make $42,000 per year working all year. And these days most farmers have a lot more than $120,000 invested in one machine or one piece of land and many would be very happy if they had $42,000 to spend after farming all year.
This is the potential return from selling covered calls. Do you want to own the stock, not work and the buck a year dividend, or do you want to own the stock, work a little, get a buck a MONTH selling covered calls and keep the dividend. Once you learn this strategy there’s almost no reason why a family has to be short of spending money.
There are stocks that might pay a higher premium but often they move up and down more.
I get the comment that options are risky. OK, let me set the record straight. The people who buy the calls I sell can see their option expire worthless. In fact about 80 to 95 per cent of them do. But we SELL the call option and we get the cash that day. If the stock goes up we can buy the call back and sell at another price or month for another premium. And if the stock doesn’t go above the price we sell the call, and we keep the money and the stock. And we keep the dividend. So how can this be risky? Anyone who tells you that selling covered calls is risky likely doesn’t understand the strategy.
Of course some critic would say that selling calls on Nortel didn’t work. Well, then don’t buy stocks that are falling. Keep in mind too that any person could have bought a put on Nortel and made a fortune as the stock dropped.
Warren Buffet goes a step further. He sells puts on stocks he might want to buy. I do once in a while, too. This strategy is restricted to experienced option traders, but it is a way to drop the price of a stock we might want to buy. In fact, once I learned this stuff I can buy a stock, collect a dividend, sell a covered call and sell a put. Plus we can make capital gain. That’s four ways to make money with the same stock. Selling covered calls is one of the most conservative money making strategies around. It’s also one of the least understood strategies around.
Andy Sirski manages his portfolio and publishes a newsletter called StocksTalk where he teaches readers how to sell covered calls on good stocks. If you want a free one-month subscription send an email to [email protected]or Google StocksTalk.net.