By Aussie Rob
Wow, my last two articles have rattled a few people's cages and got their creative investing juices flowing. I've been inundated with enquires about people wanting to learn more about 'renting shares'. So let's dig a bit deeper to give you a better understanding on how to manage this incredible cash-flow strategy.
This is the first of a four-part series I've created to teach you step-by-step how to potentially achieve total financial freedom for life, so 'ya' better keep an eye on the newsstand or better still, subscribe to this magazine so 'ya' don't miss out on future golden nuggets!
Okay, let's get into it…
Writing Covered Calls is the strategy commonly known as share renting. It involves buying shares and then writing a Call Option against them.
So what does this mean in English?
"There's money to be made here so let's make it that bloody exciting you won't want to put this magazine down!" Yeah I know, we live in a world of instant gratification where we want everything now, right now…. I hear ya screamin' already, "Show me the Money!"
But it won't happen. You have to learn the basic, boring fundamentals first. You have to learn the essentials of what options are all about and the nuances of why, what, how and when before we get into 'makin' the moula'.
Here's a basic summary of options:
I don't know why people make options sound so complicated because they are so simple. You see, there are only two options:
Calls increase in value when a share goes up while conversely, puts decrease in value when a share goes down.
The best way to remember the difference between Calls and Puts is to try and remember back to your dating days at High School. I had my eye on a hot little chick and finally got the courage to pick UP the phone to CALL her out on a date. And guess what she said?
Ahh great, thanks for the confidence! :-))))
You were right, she said 'No', so I put the phone back down. (Calls up and puts down). So the best way to remember the difference between calls and puts is to think about how lousy my sex life was in High School.
Okay, let's get serious now. Why and when would you use Calls and Puts? Well, if you thought a share was going up, you would buy a Call. Why, because a Call costs a heck of a lot less than the shares. Buying Calls is a way to capitalise on the capital gains of a share while only putting a tiny amount of money on the table. For example:
If a share was trading at say, $20, you could buy a $20 Call for $1. You are paying $1 per share for the rights to buy the share at $20.
If you didn't buy Calls and simply bought the share for $20 and it went up to $25, you would have made $5 on a $20 investment, or in other words, 25%.
Now here comes the real exciting part….
If you bought the $20 Call option for $1 and the share went up to $25, you have the right to exercise your option and buy the share at $20. Alternatively, the Call would now be worth $5, so if you were only interested in making the money and not actually buying the share, you would simply sell the Call for $5 and not exercise your rights to buy the share.
Buying a Call for $1 and then selling it for $5 gives you a whopping 500% return compared with only 25% if you bought the share for just $20 and then sold it for $25. Pretty cool, eh?
Do you now know why I ask, why on earth would you ever buy shares?
Why on earth would you ever pay $20 for a share when you could pay only $1 to have the right to buy the share? Interesting, eh?
And on top of that, what about the risk?
Well, how far can a $20 share fall? That's right, it could go to zero. Therefore your maximum risk would be $20. Now on the flip side, if you bought an option for $1, the maximum you could ever lose is the $1 premium that you paid. You see, you're actually paying $1 per share for the 'right to buy' the share.
It goes without saying, if the share goes up, you would exercise your rights to buy the share so you can capitalise on the capital gains, or just sell the option for a profit. Conversely, if the share went down, you would never exercise your rights to buy it. For example, if the $20 share went down to say $15. You'd never exercise your rights to buy it for $20 when the market value is only $15.
What an amazing difference in risk:
Hmmm, a $5 loss or only a $1 loss? Tough decision.
Bottom Line: When you buy Calls you want the share to go up! Okay, so now you know what buying Calls is all about and why people would do it. Next edition I'm gunna teach ya the other side of the transaction and that is, what selling – or in option jargon – what writing Calls is all about.
If you want to fast-track your learning about this strategy, you can check it out at my Foundation's website: www.aussierobfoundation.org
Aussie Rob has just released a brand new Covered Call training DVD called Aussie Rob's Share Renting DVD that teaches step-by-step how to write Covered Calls.
www.lifestyletrader.com.au/products
