Getting Paid to Invest in Stocks - Part II

(Continued from Page 1)

1. The company's stock stays strong, the option is never exercised, and the expiration date comes and goes. The contracts expire. They are over. They no longer exist. The premium money is mine forever, and in exchange for tying up $28,400 in Treasury bills, I was paid $11,600 in cash. That's a 40.84%+ return on my capital for a little more than a year. Or ...

2. The options are exercised, and I buy 2,000 shares at $20 per share for a total of $40,000. Remember, however, that only $28,400 was my original capital because $11,600 came from the premiums that were paid to me for writing the "insurance". This means that my effective cost basis on each share is only $14.20 each ($20 strike - $5.80 premium = $14.20 net cost per share)! Recall that I was considering buying 1,000 shares of Tiffany & Company outright at $29.10 per share, anyway! Had I done that, I'd now be sitting on massive unrealized losses. Instead, because of the options being exercised, I own 2,000 shares at a net cost of $14.20 per share! Given that I wanted the stock, planned on holding it for ten or twenty years, and would have been in a huge unrealized loss position were it not for the fact that I chose to write the options, I get the joy of a $14.20 cost basis instead of a $29.10 cost basis.

   Either way, I win. Even if the company goes bankrupt (which I do not think is even a remote possibility in the case of Tiffany & Company but, hey, nothing is certain in this world � who'd have thought that the investment banks wouldn't be around today?) I'd be in the same boat as if I'd just bought the stock outright. So, no matter what happens, I win. It really is a case of having your cake and eating it, too. Even if the options are exercised, I'm going to outperform the stock by the sum of the return on the capital tied up in the contract plus the interest earned on the investment in Treasury Bills. An advantage of that kind is very, very substantial. Remember that even small differences in return levels result in vastly different results due to the power of compounding � an investor that gets an extra 3% each year, on average, over 50 years will have 300% more money than his contemporaries.

   These are the types of special operations we've been taking advantage of through the personal accounts of my family, as well as those of my companies, as this volatility has gotten out of control. The risk / reward payoff for some stocks are so stupidly out of whack, in my opinion, that we've been virtually minting money from headquarters, writing contracts on stocks that we are happy to own outright. As we are privately held by a close group of investors, we have no pressure from analysts or reporters. We can simply do what makes sense for us, as owners, regardless of the price fluctuations that may occur in the interim.

   Now, this strategy is not something new investors should even consider. One danger is that a novice becomes intoxicated by the massive sums of cash poured into their account in premium payments, not realizing the total amount they are on the hook for in the event all of their options got exercised. If the account is large enough, there might be a substantial enough margin cushion to buy the shares, anyway, but that could evaporate in the event of another round of widespread panic. If that were to happen, you would find yourself getting margin calls, logging in to see your broker had liquidated your stocks at massive losses, and a huge percentage of your net worth gone � wiped out � with nothing you could do about it. Don't make that mistake.