RULE #1 INVESTING CALL OPTIONS

Call options are a fantastic way to generate cash flow and reduce basis on companies we already own. When we already own a company we call a call option a “Rule #1 Call Option.” Let me briefly explain the call option definition.

What is a Call Option?

Essentially, a call option example is a coupon to get cheap milk. There’s two sides to this coupon. There’s the grocery store, which is essentially selling the coupon at a very, very, cheap price and there’s the buyer of the coupon who is getting a right to go buy this milk.

So, when we use the coupon between the store, the store has an obligation to sell the milk at a set price and the buyer of the coupon gets the right to buy that milk at a set price. That’s just a coupon and we’re used to using them all day long.

Call Option Definition

Call options are just like that. Basically, if you sell a call option to someone, you are now obligated to sell them your stock at that price. If you buy a call option you now have a right to buy that stock at that set price for a set amount of time.

Selling Call Options

Why would we do that as Rule #1 Investors? If we own this company, and we sell someone the right to buy our stock at a price higher than we think it’s worth, then we have almost no risk whatsoever. Because, if the stock price goes up to that super high price, we want to sell it anyway. We want to sell into greed and we want to buy into fear.

If there is greed going on and the stock price is shooting up like a rocket, we want to be a seller of that stock. We can pick up cash flow, by putting out and selling call options, which basically gives someone the obligation to buy our stock at that higher price so that they buy it from us. They pay us a premium and we can put that money in our pocket.

If the stock price doesn’t go up we get to keep our money. If the stock price does go up, then we sell the stock. Either way we win.

Conclusion

We love selling call options as Rule #1 Investors who already own the stock. This is because, there is virtually no risk and basically, we increase the amount of money we make when we were going to sell anyways.

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About Phil Town – Phil Town is an investment advisor, hedge fund manager, two-time NY Times best-selling author, ex-Grand Canyon river guide and a former Lieutenant in the US Army Special Forces. He and his wife, Melissa, share a passion for horses, polo and eventing. Phil’s goal is to help you learn how to invest and achieve financial independence. You can follow him on google+, facebook, and twitter.

  • Garrett

    Rulers,

    Costco (COST) is on my watchlist. I missed an opportunity to buy this great one over the summer when it was trading at $114. Now it’s over $140.00

    There’s some great stories on CNBC about Costco if you want to learn more about why this company is killing Sam’s Club, BJ’s and other discount bulk sellers.

    http://www.cnbc.com/id/46603589#.

    To Your Wealth!

    Garrett

  • Garrett

    Rulers,

    I finished reading Guy Spier’s book The Education of a Value Investor.

    I’d encourage you to read it too. I picked up some valuable lessons and I especially enjoyed reading his thoughts while the market was crashing in 2008-2009.

    I have a plethora of other books on my list now that he mentioned in his book and several lessons he learned the hard way that I need to incorporate into my own investing.

    Let’ me know if any of you decide to read it. I could really relate to many of his experiences in one way or another.

    To Your Wealth!

    Garrett

  • Garrett

    Rulers,

    I have along side a book titled The Education of a Value Investor by Guy Spier. I’m going to type out the intro with my own fast typing fingers because I think there is something valuable about what he has to share to us as Rule #1 Investors. After I read his intro, I was compelled to get his book.

    Here you are – any typos are clearly mine.

    “My goal in writing this book is to share some of what I’ve learned on my path as an investor. It’s about the education of THIS investor, not any other investor. This story is not an investment how-to. It’s not a road map. Rather, it’s the story of my journey and of what I’ve learned along the way. With my own flaws and foibles and idiosyncratic abilities – and despite my considerable blind spots.

    Over the years, I’ve stumbled across some profound insights and powerful tools that I’d like to share with you. In most cases, these are not things that are written about in textbooks. Because it’s a story about how things happen in the real world – and because the real world is a messy – the topics are broad in scope. They range from the most insignificant of habits that I’ve developed, like what to read first, to the grandest: whom to choose as heroes and mentors and how their wisdom can change your life.

    This book traces the arc of a transformation. I started off as a Gordon Gekko wannabe – brash, shortsighted, and entirely out for myself. Then a series of transformations and self-realizations led me on a path from Benjamin Graham’s The Intelligent Investor to Ruane Cunniff to Poor Charlies Almanack to Robert Cialdini, then to meeting Mohnish Pabrai and lunch with Warren Buffet. That $650,100 meal had a lifetime changing impact on me, as you will see.

    Within one year of my meeting with Buffett, I let two-thirds of my staff in New York go, stashed half of my family’s belongings in storage, and shipped the other half to Zurich, where we went to live. I stopped charging management fees to new investors in my funds. I switched off my Bloomberg monitor. And I renounced my perilous addiction to checking stock prices on a minute-by-minute basis.

    I’m not necessarily advocating that you should also have lunch with Warren Buffett – especially now that the price tag has soared, hitting a high of $3.46 Million in 2012! And I’m not claiming to have a special understanding of him either. What I can tell you is that he has had an extraordinary impact on how I invest and on the way I live my life. My hope is that I can share some of these lessons that I’ve derived from him so that they will benefit you as much as they have benefited me.

    It took me the best part of two decades to get onto a more enlightened path in my life, and I’ve made many missteps and lost much time along the way. Hopefully, this book will help you to reach your enlightened path faster, and with fewer missteps. As Buffett once said, “Try to learn from your mistakes – better yet, learn from the mistakes of others!”

    I submit to you that if you learn only some of the lessons here, you cannot help but become rich – and perhaps wildly rich. Certainly, the wisdom I’ve gleaned – not just from my heroes, but from my own mistakes and successes – has helped me immeasurably as an investor. As I write this, I’ve had a cumulative return of 463 percent since founding the Aquamarine Fund in 1997, versus 167 percent for the S&P 500 index. In other words, $1 million invested in the fund would now be worth $5.63 million, versus $2.7 million if it had been invested in the S&P 500.

    But this book is also about the inner game of investing, and by extension, the inner game of life. As I’ve come to discover, investing is about much more than money. So as your wealth grows, I hope you will also come to realize that the money is largely irrelevant. And what you will want to do with the bulk of your wealth is give it back to society.

    You’re not quite sure about that last part? That’s okay. For much of my life, I wasn’t sure about it myself, and a part of e still doubts it. Like you, I’m a work in progress.

    We’re told a lot these days about why capitalism has failed us. We’re told that greedy bankers and irresponsible CEOs need to be reined in with more stringent regulations, and that wealth should be more aggressively redistributed. Perhaps. But greed can also be a vehicle to something deeper and more soulful. In my experience, you can start out as a hungry young capitalist, driven almost entirely by greed and find that it gradually leads you to a more enlightened mind-set. In that case, greed may be good after all – not if it merely motivates you to acquire more, but if it drives you toward that inner journey of spiritual growth and enlightenment.

    I expand on that lesson at the very end. But first, let’s enter the belly of the beast.

    From the Introduction of The Education of a Value Investor by Guy Spier.

    To Your Wealth!

    Garrett

  • Walter

    >>Within five years, Phil Town had built a borrowed $1,000 into $1 million.

    Good for you. With that said, as there are many phonies out there, can you provide audited proof about that claim to the general public? Of course you might say I don’t have to et et, but just trying to validate if you are real or bs.

    I know in the past you have declined to provide info on your real returns, still not sure why, if you are claiming to be that good.

  • Doug

    Thank you for the excellent information on covered calls. On another note, for those following DVA, note the CEO has reported he plans to sell some of his shares. Whether this planned sale is meaningful is up to each of us to decide as we do Rule1 research; (some people use a guideline that the insider sale must represent more than 30% of total holdings to be meaningful, for example). Anyway, I only mention it here in case you follow this company and you happened to have missed it.
    http://online.barrons.com/mdc/public/page/9_3024-insider1.html