Ask Mike:
Please explain more about your covered call strategy.

Question:

Albert from Arlington writes:

Mike,

I am a new subscriber to your service and wanted to tell you that you have the best service I have ever used. And, I have tried them all.

I particularly like the way you take the time to explain what you are doing and don't hide anything from us. Your approach to investing makes the most sense to me. Thank you!

I would like to know a little more about how you are using the trends in a stock's price to help you pick the right stock and covered call strategy? How do you go about picking the expiration month?

I signed up as a Preferred Level subscriber, so I have access to everything, but I am concentrating on your Stock and Option Portfolio and Covered Call-5 portfolios. I have tried to make money with covered calls in the past and have done ok, but nothing like you are doing. And, I never thought about buying a stock for the sole purpose of selling the call. I can't believe something so simple can make so much sense. I always thought that the strategy was to keep the stock and hopefully let the call expire worthless and just make a little extra money on the sale of calls against the stock. I like your way a lot better.

Keep up the good work!

Albert

Mike's Response:

Hello Albert,

Thank you for writing and the kind remarks.

Yes, the Covered Call portfolios are really doing well. Keep in mind these portfolios are brand new and it takes time to know whether a strategy is going to consistently generate profits over longer periods of time. But, you are right... it sure looks great so far.

You are also right that our covered call strategy is quite a bit different from the 'normal' strategy of holding a stock and augmenting the income on the stock by selling calls against it over and over, with the objective of never selling the stock. There is nothing wrong with this strategy and it is a great way to make a little extra income on a stock while it appreciates (hopefully) over time.

The TurnerTrends covered call strategy is considerably different... Allow me to explain:

The first thing we do is to look for stocks that have the following characteristics:

• Relatively low volatility as determined by our Expected Move formula, in relation to the price of the call plus any intervening dividends, and
• A stop loss price that significantly diminishes any potential downside risk so that if triggered the income from the sale of the call plus any dividends will get us out fairly close to zero cost, and
• Strong growth fundamentals to support upward pricing trends, and
• A strong buy signal from our technical trend analysis system.

Then, we eliminate any/all potential trades that violate our diversification rules of no more than 30% in any one Sector and no more than 20% in any one Industry.

For the Covered Call-5, we go one step further and eliminate any stock that is priced at more than $70. We do this to make it easier for anyone matching us in our Covered Call-5 to be able to put the trade on at a lower outlay of cash.

Our objective is to have the stock called away from us. This is a critically important part of our strategy.

We want to make money on the sale of the stock, so in most cases, we will sell calls with a strike price above the current price of the stock. This is not always the case, if we believe we can make a higher return by just making money on the time value of the call and not the intrinsic (share price) value of the exercise price.

In each of our trades our goal is to make an annualized return of 25% or more. So, we take time into account, the income from the sale of the calls, the income from any dividends and the income from the sale of the stock if it is called away.

It follows then, that if we can limit or minimize our downside risk if the stock's price moves against us and we look for upside trades that net us an annualized return of 25% or more, we believe the long-term return on this strategy will be substantial.

And... one last thing... if the stock's price moves against us to the point that our stop loss is triggered, we will buy the calls back (generally at a cost of only a few cents) and then sell the stock. Exiting in this manner allows this strategy to be traded in an IRA account, since we buy the calls back first. Some brokerages will make the exit trade as a single trade others will 'leg' into the trade by buying the calls first and then selling the stock.

The reason this is important for IRA accounts is that you cannot short in an IRA account. If you sold the stock before buying the calls, you would be short the calls which is not allowed.

Thanks for writing, Albert.

Regards,

Mike