DIFCCO Part 3 - CCO stands for Covered Call Options and Coco

Now for the final piece in our grand strategy - Covered Call Options.

Here’s the gist of what we are doing here …

So I'm a big fan of Rich Dad, Poor Dad: What the Rich Teach Their Kids About Money--That the Poor and Middle Class Do Not!but I don’t particularly like real estate – I am debt averse and tenant averse. So what other options do I and other like-minded individuals have to generate monthly cash flow? Well we can go buy a dozen vending machines and see how that works out or we can look to income producing, dividend stocks. Now of course Rich Dad doesn’t like the stock market because he has no control, no leverage and the volatility make s him cringe, but we are not investing for capital gains, we are investing for income. So although the dividend can always be taken away, if it is taken away, we'll just reinvest the money in another dividend payer. This is the cost of doing business and the equivalent of vacancy loss from the real estate world.

What is the likelihood of losing the dividend? Well as part of our fundamental analysis we hopefully selected a stock that is consistent in its dividend payout and perhaps the company has reputation for raising it. If it does cut it or drop it altogether, we surf it over to another dividend payer. This will lead to higher transaction costs and taxes sure but this is the cost of doing business. What we truly lose is deflated buying paper to replace the lost income. But a) call options expire out of the money 80% of the time and b) if we are savy investors we will find an equivalent deal anyway.

Now that we have our dividend stock that we assume can gross us about $175 per 15 k invested (we’re shooting for a high payer, somewhere above 10%) that we found using sound fundamental analysis from one of the masters – the man who put Mag in Magellan - Peter Lynch.

One Up On Wall Street : How To Use What You Already Know To Make Money In The Market

Now, let’s increase the income through premiums from Writing Covered Call Options. This means more checks in the mail for us.

This piece might not as be as passive as everyone would like it … e.g. your not sitting in the lazy boy as the checks float into the mailbox while your "property manager" handles all of the work. But it is still relatively passive - you write the option once and then somewhat sit back, merely monitoring the stock, and the checks roll in. Plus, even real estate is not 100% passive.

In a real estate investment, you have to hunt the deal down, deal with attorneys, accountants, the banker, insurance people and the property manager. When you first start off, you're not going to have a property management unless you want to cashflow negatively. You are most likely going to be doing the repairs, maintenance, evictions and rent collection yourself making beginning real estate investment 100% non-passive. When you compare this with the research, analysis, buy and sell decisions and covered call option writing that comes along with DIFCCO strategy, it is fair to say that both strategies are equally passive. Plus, once you get good at it, it becomes more automatic and you can make bigger amounts of money with more ease.

I will admit up front I am not an expert at covered call options just yet but I would like to point out four things off of the bat:

1) Writing Covered Call Options is one of the most conservative call option strategies available – you own the underlying instrument so it can be delivered if the option is exercised.

2) Call options end up out of the money 80% of the time – a good thing for the writer.

3) Contracts are written for 100 shares at a time so, if you own 300 shares of the underlying stock, only one-third of your position is called away if the option is exercised.

4) You are investing for dividends on the underlying stock not capital gains. If the worst case scenario becomes true under a call write, then who cares? If you bought the stock at $60 and it goes up to $70 and you have to sell it at a strike price at $60 you lose out on a gain of $1000 – but that’s on paper! And you never invested from the get go for paper capital gains. You invested for income. You still get to keep the premium – you made money on the deal!

The worst thing that can happen to you under a covered call write in this strategy is that part of your income is called away. But a) it is only 1/3 of your income in this case b) you can buy more shares and c) you get to keep the premium. Of course your buying power for the income has been diminished - a third of your $175 has been called away and now it’s going to cost you an extra $1000 or say a total of $6000 versus $5000 out of an original $15000 investment to buy that income back. Still, there might be an opportunity to buy that income back at a lower price through another stock that is on sale and plus, calls end up out of the money 80% of the time!

Three additional points:

1) Make sure the stock is option-able from the get go by going to http://www.cboe.com/DelayedQuote/QuoteTable.aspx and see if you can retrieve a quote on the stock.

2) Most big brokers will allow you to write covered call options against an individual stock. In my account I have to indicate in my preferences that I can write options on my account and I have to call a broker to get set up. Once you open an account with a major broker (Fidelity, Schwab) poke around and dig up all the information the site offers on options.

3) Do your homework. Even though covered call option writes are the least riskiest form of options since you can deliver the underlying stock if called, stepping into options is a whole new world. Make sure to put the time in up front to really understand what you are doing read a few good books and paper-trade.

Here are some resources:

Options Made Easy: Your Guide to Profitable Trading (2nd Edition)

The Bible of Options Strategies: The Definitive Guide for Practical Trading Strategies

The Complete Guide to Option Selling

Get Rich With Options: Four Winning Strategies Straight from the Exchange Floor (Agora Series)

Trading Options For Dummies (For Dummies (Business & Personal Finance))


The estimates of a premium range from approximately $150 to $300. A call option lasts typically for 30 to 90 days. If you can work this out to a per month basis you could generate an additional, approximate 200 bucks a month.

So, to sum up the entire DIFCCO strategy (again). You are going to generate at least $175 a month in dividend income a month by selecting three stocks that generate a dividend yield in excess of 10% using the dividend screening parameters outlined in DIFCCO part 2. This initial list is just that, an initial list to be researched further using our Lynch Fundamental Analysis and other resources as described in Part 2. You will then write covered call options against your position (after becoming a covered call writing expert first). Initially, you should only write against the 100 shares, the minimum for a covered call write. This will give you some cushion for a learning curve and protect the majority of your income if your stock is called away.

From the covered call option write, you expect to generate at least $200 a month once you get up to speed - approximately one covered call write a month. This income coupled with your $175 in dividends a month gives you a grand total of $375 a month.

Not bad for zero tenants and zero debt. In my area I would have to own two 4-plexes with an approximate total of $80,000 down (4-plexes go for ~ $200k in this area with a 20% down payment nowadays.) I would be carrying loans of $320,000 – of course that is all leveraged so that is a huge trade off but if continue on the road as an options expert then you can learn to leverage stocks by buying and selling stocks - and you still won't have to carry debt.

Of course, I’m not real estate averse. I think real estate investment should be a part of any good asset diversification - and I don’t mean merely investing across multiple mutual funds. Real estate should be a part of any healthy investment plan. Especially if the giant sucking sound of baby boomers withdrawing their money from the markets as mentioned in Rich Dad’s "Prophecy" comes true. I merely wanted to present an alternative and not leave all passive income enthusiasts feeling as if they had to buy large amounts of real estate.



Thus, the alternative to Rich Dad Poor Dad.

Rich Dad, Poor Dad: What the Rich Teach Their Kids About Money--That the Poor and Middle Class Do Not!

Rich Dad's Advisors: The Advanced Guide to Real Estate Investing: How to Identify the Hottest Markets and Secure the Best Deals (Rich Dad's Advisors)

The Standard & Poor's Guide to Building Wealth with Dividend Stocks (Standard & Poor's Guide to)