There’s a financial formula used by some of the largest banks on Wall Street, including Goldman Sachs (NYSE: GS), Morgan Stanley (NYSE: MS), JPMorgan Chase (NYSE: JPM) and Bank of America (NYSE: BAC).
It’s the secret behind many of their top money-making strategies, and they’ve been using it for decades to rake in billions for themselves and their wealthy clients.
I use the formula myself, and I’ve been able to generate an average annualized return of 18.4% with one of the easiest and most conservative strategies in the market.
The formula I’m talking about is the Black-Scholes model.If you’re familiar with options, then you may have heard of it before.
It’s the most important development in financial engineering because it allows ordinary investors to profit from options just like Wall Street traders.
It was developed by Fischer Black, Myron Scholes and Robert Merton in the early 1970s.
Their formula provided a rational way to determine how much an option is worth. Thanks to their discovery, the three received the Nobel Prize in economics.
To understand why it’s important, you have to consider how things were before their discovery.
You see, up until this time, option pricing was done in many different ways, sometimes quite arbitrarily. As a result, it was difficult for ordinary investors to use options without being taken advantage of.
But the Black-Scholes model changed that. It created a formula that standardized the prices of options. This allowed options to be traded in large volumes at transparent prices, and created a vast options market, which today is worth trillions of dollars.
For our purposes, what makes the Black-Scholes model really exciting is that it helps predict future price changes, which lets you find the options trades that are most likely to succeed. And thanks to online calculators like this one, you don’t have to be a math whiz to use it; just enter a few numbers like the expiration date and strike price, and you’re ready to go.
(The Black-Scholes model is highly complex, with many variables and mathematical operations. If you’re interested in understanding the formula and the math behind it, I recommend this video from the online Kahn Academy.)
There are many different ways to trade options, but what most people don’t know is that they can use options to generate what I call “instant income” from the stocks you already own.
Think about it like this. You have an entire portfolio of stocks. They sit in your 401(k), IRA or brokerage account — just moving along with the market and occasionally dishing out some dividends. But what if you could squeeze a little more cash out of those idle stocks?
I’m not talking about anything risky. It’s one of the most basic options strategies — one that the large institutions use to rake in billions for their wealthy clients — and it’s what I focus on in my premium advisory Maximum Income.
The technique is called “selling covered calls” or “covered call writing.”
Let me show you how this works with a recent trade that I sent to my subscribers.
In February, we bought 100 shares of Royal Caribbean Cruises (NYSE: RCL) for around $75.55 per share. We sold shares at $82.50 five months later. While we held shares, it also paid out $0.60 in dividends, giving us a total return of around 10%.
This is a respectable return for a position held about five months but, as I mentioned before, what if we could juice those returns a little?
With did just that using covered calls.
In those five months, we sold four different options contracts on RCL. We were able to pocket an additional $5.57 per share, or $557 per contract (each contract controls 100 shares) in extra income. Including the dividend payment, this lowered our cost basis to $69.38 ($75.55 – $5.57 – $0.60). So when we sold for $82.50, we actually locked in an 18.9% return on our cost basis — nearly double the gain we would have made had we just let our shares remain idle in our brokerage account.
Generating income from covered calls can act like gasoline on a fire when stocks are climbing.
– Amber Hestla
Source: Profitable Trading