Many of us take walking for granted. We get out of the car and walk to the store. We get up from the couch and make a beeline for the refrigerator. We don’t think too much about it, and for the most part, we walk directly to where we want to go.
But if you’ve ever watched a baby in its early stages of learning to walk, you know the process is not so smooth.
That’s what the Trump administration’s tariff policy feels like to me. It’s trying to find its footing and get to where it wants to go, but sometimes it loses its balance or its legs give out and it goes tumbling forward.
After several days of gut-wrenching declines in the stock market and spikes in interest rates, President Trump capitulated, reportedly after watching JPMorgan Chase CEO Jamie Dimon say on Fox News that a recession was a “likely outcome” due to the trade war. Trump went on to announce a 90-day pause on the reciprocal tariffs against all countries except for China. (The 10% across-the-board tariffs are still in effect.)
On Friday, the administration announced that electronics from China would be exempt from the tariffs. Then, on Sunday, the president said the Chinese-made electronics would still be subject to tariffs but would now be under the original 20% fentanyl-related tariff rather than the much higher reciprocal tariff.
It’s like the baby that’s not sure which direction it wants to go and may or may not get there.
With the news constantly changing, it’s no surprise that the markets are volatile and have made big swings up and down.
It is very difficult to trade these kinds of chaotic markets. But fortunately, there are strategies that can help generate big income and lower your risk during times such as these.
In a two-part series over the next couple of weeks, I’ll be discussing two different approaches investors can take.
The first? Selling options.
When volatility spikes, this is one of the best strategies you can employ. Let’s discuss the benefits and risks of two types of income-generating option plays: covered calls and naked puts.
Covered Calls
A covered call is when you own a stock and sell an out-of-the-money call along with it. The call buyer pays you a premium (which you keep) for the right to buy your stock at the strike price at any time before expiration.
For example, let’s say you buy 100 shares of Mondelez International (Nasdaq: MDLZ) at $67.50. You could sell the September 19, 2025, $70 calls for $3.50. Options contracts represent 100 shares, so you would collect $350.
That $350 equals a 5% return on your investment, which is a fantastic yield for holding a stock for five months or less. If the stock rises above $70, the call buyer has the right to buy your stock at $70 – no matter where it’s trading – at any time up until September 19.
However, there are two risks with covered calls. If the stock soars well above $70, you will still have to sell it at $70, so there is risk that you miss out on future gains.
The stock could also fall sharply, in which case you will lose money on it. But the $350 you already collected will offset some of those losses. And if the stock falls, you could always sell it and buy back the call for less than you sold it for.
For example, let’s say the stock drops to $60. You may decide to sell the stock and buy back the call to avoid further losses. If you buy back the call for $1, you’ve profited $2.50 on the call, which will help offset your $7.50 loss on the stock.
You can also collect dividends while you hold the stock.
So let’s say on September 19, the stock is trading at $72 and is called away from you at $70. You’ve earned a $2.50 profit on the stock because you bought at $67.50 and sold at $70. You’ve collected a $3.50 premium from selling the call, and you’ve been paid what will likely be a $0.47 per share dividend.
Your total return would be 9.5% in five months, which is fantastic.
Naked Puts
Selling a naked put means you’re selling a put on a stock you do not own. (With options, “covered” means you own the underlying stock, and “naked” means you do not own the underlying stock.)
You should only sell naked puts on stocks you want to own at a lower price.
Let’s use Citigroup (NYSE: C) as an example. The stock is trading at $64. Perhaps you think that’s too expensive, but you would be willing to buy it at $55.
In that case, you could sell the September 19, 2025, $55 puts for $3. This means you must buy the stock for $55 if the buyer of the put demands it.
If the stock never reaches $55, you keep the $3 per share ($300 per contract) and nothing else happens. The risk is that the stock drops far below $55 and you have to buy the stock at $55. If you change your mind on the stock and are no longer willing to buy it at $55, you could always buy back the put, but it may be at a loss since the stock has fallen.
If the stock falls to $55 and you do buy it, you still keep the $3 option premium, effectively reducing your buy price to $52.
And remember, you also keep the $3 per share if the stock doesn’t go that low. It’s like being the insurance company for someone who’s worried about their stock price going down. If it doesn’t, you keep the premium – the same way the insurance company keeps your premium when your house doesn’t burn down.
The increased volatility in the markets right now means option prices are high, which is an option seller’s dream. Eventually, they will return to normal, but if you sell options now, you’re selling high, and you can either buy back low later or simply do nothing and keep the entire premium.
Stay tuned for the second part of this series next week, where I’ll be discussing the absolute best way to stabilize and protect your portfolio in volatile markets.