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A Safe Options Strategy for Retired Investors

By Dr. David Eifrig, editor, Retirement Trader
Saturday, August 7, 2010

Most people know stock options are a great way to get rich in America...
Take Stephen Hemsley, CEO of the big insurance firm United Health Group. His 2009 salary came in around $9 million. But a decade earlier, he received stock options as part of his compensation package. In 2009, he exercised 4.9 million of them for a total gain of $98.6 million.
These huge option payoffs are just business as usual on Wall Street... and most of the time, there's nothing wrong with them. Several of my good friends will never have to work again because they exercised options on thousands of shares of company stock.
These options allow people to buy a company's shares for a small amount of money, then eventually sell the shares for much higher prices. They can bring in hundreds of thousands of dollars of extra income.
Most people have to work for years to receive stock options from their employer – or use risky trading strategies to acquire in-the-money options. They have no idea there's a way to receive free stock options any time you want them.
Acquiring free stock options is one of the easiest, safest ways to invest in the stock market. It's a strategy I learned more than 20 years ago while trading derivatives on Wall Street. And I guarantee 99 out of 100 investors have never heard of it before.
Let me give you an example of what I mean...
One of my favorite companies in the medical and biotech stock sector is $100 billion British drug giant GlaxoSmithKline (GSK).
GSK is an innovative Big Pharma company with an exceptional research & development process. It constantly increases shareholder equity... and has a culture of treating investors well in the form of big dividend payments.
Right now, GSK pays an annual dividend of $1.84 per share. This annual dividend payment is important. It's the key to our "free stock option."
I love to own safe stocks that pay big dividends like GSK. But I also like the tremendous leveraging power stock options provide. That's why I often buy these sorts of stocks... then take the money I receive in dividends and buy call options with them. I fund the speculative portion of my position with the company's dividend.
Making these trades is like getting free stock options.
Let me show you how a trade like this can work...
Right now, GSK trades around $35 a share. The January 2012 call option on GSK with a strike price of $40 (which will appreciate tremendously if GSK rises a good deal) sells for just $1.90. So you can use your dividend to pay for the option. Essentially, you're getting the option free.
Now, let's say GSK absolutely soars, hitting $70 per share by January 2012. Your gain on the stock is a solid 100%. But your "free" option is now worth $30. Your gain on your whole position will be 186%. That's the kind of leverage an option can give you.
If GSK trades modestly higher, settling around $45 per share by January 2012, you've made about 25% on your stock. Still pretty good for 18 months. But your extra gain from the free option kicks your profits up to 43%. That's a terrific return on a super-safe stock.
The thing about this strategy is you're not taking on an ounce more risk than you are when you just buy the stock. So your downside is exactly the same (I recommend using a 25% trailing stop on most of my positions). But your upside is dramatically higher. And if you use the dividend to cover the cost of the option – you're getting all that upside free.
Now, there are a lot of moving parts to this trade that I don't have the space to cover here. But one thing to note is that this isn't a "covered call" trade, where you buy a stock and SELL a call option against your shares.
There's a time and place for covered calls... But in situations where you want full exposure to the upside, and you can pay for an option with a company's rich dividend, you want to buy a stock and BUY the calls. You'll get a lot more "juice" on conservative trades like GSK.
I recommended a version of this GSK trade for my Retirement Trader subscribers back in April (it's still an attractive idea). But even if you're not interested in putting on this trade today, here's what you need to understand: There are a lot of ways to use options SAFELY.
Many investors are afraid of options. They think they might as well toss their quarters in a slot machine. And given the way a lot of traders use options, they're right.
But if you're a conservative investor, especially if you're retired or nearing retirement, consider this "free option" strategy and others like it. There are many different ways to use options in order to make great gains... while risking less than you do in conventional stock positions.
Here's to our health, wealth, and a great retirement,
Doc Eifrig

Further Reading:

For high-upside trading, Doc's "free option" strategy works best. But if you're looking to collect income, you definitely want covered calls in your toolbox. Tom Dyson recently showed DailyWealth readers how to make as much as 70% a year in income – safely – by writing covered calls. Learn how here: The 54% Dividend Capture.
If you like the idea of using safe options strategies to up your income, don't miss Porter Stansberry's classic how-to essay. With the method he describes, you can make 48% on an annualized basis using the market's highest-quality stocks. Lean how to earn cash immediately – and profit even if stocks don't rise – here: How to Sell Hurricane Insurance After the Storm.

Market Notes


Don't count the inflation crowd out just yet...
As we've noted several times this year, one of the great investment questions of our time is, "Is the U.S. government's crazed borrowing and spending going to lead to higher prices and, thus, inflation? Or are banks and consumers in such bad shape that lower economic activity and lower prices mean deflation is on the way?"
Along with our friend and master investor Chris Weber, we come down on the "prepare for both" side of this debate. But we still monitor who is winning the argument by tracking the price of commodities. Inflation is the debasement of paper money. If the prices of things like gold, oil, and copper are soaring, it means each unit of paper money is becoming worth less and less.
Several months ago, commodities suffered a sharp decline that took the benchmark commodity index, the CRB, to eight-month lows. This price action gave weight to the deflation argument. But as you can see from our chart of the week, the CRB index has staged a big rally in the past few weeks... and is within spitting distance of a one-year high. This is a much needed "talking point" for those in the inflation camp, who have spent the past few months like General Washington's troops did at Valley Forge: cold and lonely.

The CRB has staged a big rally

Stat of the week


Estimated number of Americans who received food stamps in the month of May... the highest number in the history of the program.
Work hard next week. The government needs your money to buy more votes.

In The Daily Crux

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