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Return on Investment (ROI) - How to Get 18% in a 1% World
What would you say if I presented an opportunity to make $26.00 if you would lend me $2,400? Most people would laugh, but is this a good return on your money.
Well, first off, we would need a bit more information. What if this loan was for only three weeks? Again, one would probably laugh because of the risking getting your $2,400 back seems like a lot to gain a mere $26.00. But let's walk through a little math before we jump to conclusion.
$26 for three weeks is equivalent to $8.66 or $450.66 per year, which is an 18.77% annualized return on your money. Having stated it that way, the mere $26 is a bit better looking isn't it.
This morning I personally committed $2,400 for a $26 return in my ROTH IRA. But now the big question is the risk factor. How much can I loose.
Quite simply while theoretically I could loose it all the chances of that happening is very unlikely. You see, I sold a Put Option on a company that I would really like to own the stock of. In fact, if I were to own the stock I would receive a 4% dividend.
The option that I sold has a strike price of $24.00. If, in three weeks, this option that I sold for $31 (less a $5 commission) will expire worthless if the stock is trading above $24.00 meaning that I will pocket the net $26 for each option I sold. My risk is, if the stock drops below $24 I will be obligated to buy 100 shares of this companies stock at $24 per share. Something I have no problem doing. In essence, the cost per share will be $23.74 because I will get to keep the net $26 that I received from the option.
So here's the only two things that can happen:
1. The option expires worthless and I get an $18.77% return on my money, or
2. I own 100 shares of a stock that I want to own earning a 4% dividend
The problem that most of us have when trying to calculate the return on our money is that we forget about the percentage return. If the dollar amount is not high enough then we won't even consider the opportunity. In the whole scheme of life $26 is statistically nothing. But allow $2,400 to earn $26 in three weeks with very little risk is a very attractive return.
Learning how to sell options is a phenomenal way to consistently earn high yields in a low interest rate environment. But the key is educating yourself. When you implement this strategy against high quality companies whose stock you would be willing to own for the long term you can actually put yourself in a very lucrative position. Education is the key!