"One of the funny things about the stock market is that every time one person buys, another sells, and both think they are astute"
-- William Feather, American Publisher and Author.
To me it was intriguing and I wanted to understand how options worked. The more I found out about them the more fascinated I became. It seemed like I was creating money out of thin air (which of course I wasn’t). But it was also bewildering because options allow for so many different possibilities. Options represent both Hope and Protection combined with the security of Limited Risk for buyers. But for buyers options present such a low probability of success. For the seller of options it’s just the opposite. There’s no security and there’s virtually unlimited risk, but the probability of success is huge.
So I asked around to try to determine who enters these kinds of transactions. And the answer I got for the most part was, “I don’t know. People who like to trade, I guess”. And as I delved further into the question, I discovered that at the time, and this was 30 years ago, most options being traded were covered call options and most of those were being traded in Florida.
Today covered call options are generally referred to as a “buy-write” transaction. An investor buys the stock and then writes a call. To understand why these were occurring most often in Florida you have to understand what a covered call option is. A “Covered Call” is an options strategy where an investor who currently holds a long position in an asset (owns the stock) sells a call option at a certain (strike) price for a certain amount of time on that stock to generate income (a fee). If the stock remains at or below the strike price at the expiration date, the call seller keeps the income (fee) and can write another call. This allows the individual to continue to receive a steady stream of income as long as the stock is not called away. If the call is written well above the current price of the stock and the stock is called away, it’ll be called away at a profit and the seller also keeps the option income (fee). Nice, huh?
Now back to why Florida. Well, Florida has a lot of old people. And old people are the ones that have a lot of investments. People that own a great amount of stock are by nature thrifty (as in cheap). They’ve accumulated this wealth and they don’t want to part with it unless they absolutely have to. But they want their investments to grow and they want to live off the dividends that are distributed. It’s just that sometimes dividends are just not enough for these greedy people. With covered call writing, the Florida elderly suddenly had another opportunity to make money off the stocks that they already own. And remember, selling options has a high probability of success.
Having learned this, whether it was true or not, I was convinced that I needed to emulate these old rich people because that was my goal in life – to be rich when I got old. It’s still my ambition. I want to be rich when I get old someday.
To this day I still buy stocks for wealth creation and dividends. And like the old people of Florida, I sell covered calls off my positions. It’s been a great way to increase my income above and beyond simply receiving dividends. And it’s the money I receive from dividends and derivatives that fuels my portfolio these days.