For most investors, the world of “options” is another universe. Most investors don’t understand how they work, how time decay affects them, or why they can dramatically change the price when their underlying asset ‘hardly’ moved. So it's very understandable why a lot of investors simply stray away from options and stick to the ‘simpler’ investments they understand.
However, every investor should at least attempt to understand how options work and why they are important to the market. Further, most (especially long-term buy-and-hold investors) investors should, at the very least, occasionally dabble in options from time to time.
I know what you are thinking, “this guy is nuts, options trading is gambling, not investing, I have been there, done that, and I’m not doing it again.” But hear me out before your stop reading.
First off, I am a long-term buy-and-hold investor at heart, and that is what I recommend to everyone. Historically, long-term buy-and-hold investing is better than trading, short-term market timing etc., etc. However, with options, you can be long-term investors and make a little cash on the side while essentially having zero risk, at least zero risk of losing capital.
Let me explain. The strategy is simple; you sell call options against stocks that you own. So, let’s say you own 100 shares of ABC stock. You can sell 1 call option against those 100 shares; this is called ‘selling a covered call.’ You sell the call, take the proceeds, and hope that the stock doesn’t hit your strike price before the expiration date. If that happens, you keep the premium you received when you sold the call option, then rinse and repeat. This premium will not amount to a lot of money during each individual trade. However, over the course of a few months or years, this could be a sizable amount of money.
Worst case scenario, you sell the call, and the stock hits the strike price, and your shares are sold at that strike price to whoever owns the contract. In that case, you get the money for the 100 shares and the premium the buyer gave you when you sold the call. So you take that amount and invest elsewhere, or wait for ABC stock to come back lower so you can buy back in at the same price you sold out or it, or even cheaper.
This strategy is not going to make you rich. However, it will provide income on a weekly or monthly basis. Income you can use to re-invest or pay bills and living expenses. This, of course, is a lot of work. For example, constantly selling calls and waiting for them to expire worthless or having to re-buy stock back.
So, luckily for you, the Global X Russell 2000 Covered Call ETF (RYLD) does this same strategy for you. The RYLD Exchange Traded Fund owns shares of the Russell 2000 and then sells covered calls against it as a way to produce income for its investors. Currently, the RYLD is paying out a 7.34% dividend yield, but it has been as high as 10%.
The dividend yield will vary depending on the price of the calls the ETF is selling and or if the calls the fund sells get executed or not. Furthermore, the fund may increase in value over time but moves higher will be muted due to the fact that the fund is selling calls, and if the market fly’s, the covered calls it sold will be converted, and the fund will miss out on the ‘big’ move higher. However, since you are getting a lower upside return, the downside risk is also slightly offset due to the fact that the fund is selling the calls and paying a dividend. The fund does charge an expense ratio of 0.60%, but considering the amount of work required to execute this strategy, that is not unreasonable as long as the dividend remains high; that expense ratio could be seen as cheap.
This may not be the best strategy for all investors since it does limit upside potential. Still, for anyone looking for dividend income, this is a very attractive option that should be considered.
Matt Thalman
INO.com Contributor - ETFs
Follow me on Twitter @mthalman5513
Disclosure: This contributor did not own shares of any investment mentioned above at the time this blog post was published. This article is the opinion of the contributor themselves. The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. This contributor is not receiving compensation (other than from INO.com) for their opinion.
