I know it’s been a tough week for investors to navigate the geo-political fallout and the impending Fed flux, but it’s important to note it’s been a banner year for U.S. stocks – even if we can all agree the rise in stocks has been Fed-induced. It’s juiced the market but the Fed was simply trying to create a ripple effect so that people would feel better about spending. It’s bringing the economy back to life because roughly 66% of the economy is based on the consumer spending pattern. It’s important for that particular component to do well. A big part of that is, obviously, a better job market. That’s coming but it’s again a lot slower than people had forecast or that the Fed had really wanted in its modeling.
But the Fed has done a good job in creating wealth, and we’ve can’t lose sight of the fact that the stock market hit new highs recently. We’ve got a market that really has played up well to expectations and I expect to continue higher going forward, simply because the money has to go somewhere, especially because we’ve seen all the noise and negative news come out of emerging markets recently, as well as other markets around the world, which have really struggled. It could be argued that the U.S. market has really been the only major market all year long.
But as the summer draws to a close, we’re starting to see the European market take root for a lot of the same reasons that the U.S. markets have seen strength. Europe’s economy is where the United States was about two years ago. The micro aspects of it still have a long way to go, but the macro side is just starting to come together. And within that, the financials are starting to act better than some of the other multi-nationals that are characteristic of this market.
This presents an opportunity for income investors. You can leverage the strengthening European market and relative vigor in the financials with a covered call on a top-tier European bank, UBS AG (UBS). I chose UBS over competitors like Deutsche Bank AG (DB) or Credit Suisse Group AG (CS) simply because I like UBS’ technicals more, but I’m watching the whole space closely. I particularly like covered calls because they offer upside potential along with downside protection, which is ideal in this volatile market. You don’t want to miss out on making money, but you also don’t want to be over-exposed. Here’s how I recommend you play a short-term move in UBS to pad your income and protect your assets:
For every 100 shares of UBS you own or buy at market, ‘sell to open’ one contract of the UBS Oct $21 calls for 65 cents or more. (Because a single option contract typically corresponds to 100 shares of the underlying, you simply multiply 65 cents x 100, which nets you $65 of option premium for each contract you sell, excluding commissions, of course.)
Full disclosure, while I typically guide my Cash Machine subscribers to long-term investments, I’m looking for a short-term pop in USB and I’m actually hoping that our stock shares will be called away by October options expiration. If you buy shares of UBS around $19.66, you stand to make a 10.4% return in about seven weeks.
It works like this:
Your net entry in UBS stock is $19.01. ($19.66 entry – 65 cents collected in option premium = $19.01.)
If UBS is trading above the call option’s $21 strike price at October expiration on Oct. 18, your shares will be “called away,” meaning someone is exercising their right to buy your shares of USB at the agreed-upon $21 price. Because shares of UBS are trading at more than $21, they’re getting them at a discount and you collect a defined profit:
So with a $21.00 exit price and a $19.01 net entry, that’s a 10.4% return. Not bad for less than two months—and if you’re able to buy UBS at a lower price, then it’s an even greater return.
Now, what happens if shares of UBS are trading below $21 at October expiration? Then you still get to keep the $65 premium you collected, and you keep possession of your UBS shares. You can then keep writing covered calls on the stock as long as you own it, which isn’t a bad prospect at all.
Europe is now starting to show signs that just maybe a bottom is in place. When you have developed economies starting to find their footing, it shows a broader recovery is on track and, with covered calls, investors can still safely generate returns while protecting themselves.
Bryan Perry is the editor of Cash Machine, a newsletter focused on high-yield income investing with a the goal of maintaining a blended total yield of 10% across two portfolios. Bryan is also the editor of Extreme Income which uses the power of historically cheap money to create a leveraged “baby hedge fund” strategy that paves the way to massive profits and 4x greater income.
Stay tuned! Bryan is currently working hard on a brand new strategy that amplifies your income potential by utilizing a conservative options strategy based on stocks you may already own.