DISCLAIMER: This is an interview with a friend and should be read as such. For professional investing advice, please consult your personal financial advisor. This interview should in no way be construed as professional investing advice for your personal portfolio. You are responsible for your own money, not me or Greg Hull.

Last time, Greg and Charlie and I chatted about the fruit of stock options, of exponentially increasing your earnings from average income and Charlie called us communists.

GH: You have the ability to buy and sell your options at a given price – whatever price somebody agrees on. I can buy my stock at a given price or I can sell my stock at a given price. These are options. For example, if I buy a stock at $10, Lance, but I don’t want to sell it till at least $12.50 and you come along and say, “Yeah, I’ll buy it at $12.50.” I say, “Okay, I’ll sell it to you at $12.50, but you have to give me a dollar for every share. That means I can only sell it to you, and only at $12.50.” The stock jumps, goes to $15. You’re like, “Greg? I wanna buy your stock.” Okay. I sell it to you at $12.50. You’ve just spent $13.50 on a stock that’s now worth $15. You’ve made money. I’ve now made $13.50 on a stock I paid $10 for. I’ve made money. It’s a win-win.

Here’s the other side. . .

LS: [laughs.]

GH: I buy the stock for $10 and I say I’ll sell it to you for $12.50. You pay me $1 to hold onto it, but now the stock that’s $10 only goes to $11, okay? It’s not at $12.50, so why would you want to buy it at $12.50 when you could buy it for $11? So you don’t buy it from me. You let the option expire because it only lasts for thirty days – that agreement we have only lasts for thirty days. You let it expire, and I get to keep my stock. You’re out a dollar, but I made a dollar. It’s still win-win for me. I made a dollar. The stock goes up, I make money because I made money on the stock price as well as the options. Stock stays the same, doesn’t go anywhere, I still make money because of the option and made a percentage return now. Stock goes down, not only have I leveraged my stock from selling the option, but I also have upside potential because of the dividend. I wait it out and make money. I now have a strategy that makes me money whether the stock goes up, down or stays the same.

LS: Now what’s the downside? Surely there’s a way to lose money. . .

GH: The only way to lose money is to sell the stock.

LS: Okay.

GH: If you buy a stock at $10 and it sells at $7.50,

LS: And I sell the $7.50 call?

GH: And you sell the $7.50 option, then you get called out at $7.50, you’ve lost $2.50 because they called you out. They have the right to do that. If you continue to sell the $10 and wait for the dividend, there’s no way to lose money because you own the stock.

LS: You gotta own a lot to do that.

GH: A hundred shares of any stock.

LS: Well. . . I mean like with commission.

GH: Umm. . .

LS: That starts eating into the potentiality. . . like if it’s $7.50 call, that’s only $750 on a 100-share bundle, so a good option’s what? 10 cents? 20 cents?

GH: I try and strive for 5% on the option. I’ll pull the trigger at 5%. On a $7.50 stock, you’re looking at about 37 cents, 38 cents. On 100 shares that’s $37, so commissions are gonna eat that up. Starting out with $750 isn’t gonna make that money. I tell people to generally start with a bout $5,000. That’s the point when you can actually start to see a good return on your investment. You can diversify into two, three stocks and still be comfortable. Having one stock puts all your eggs in that basket.

LS: Right.

GH: Whatever that stock does, that’s what your portfolio does. If you can spread it out over two or three stocks, you have a lot more security. Taking several positions is better than having it all in one. Yeah, I try and spread it out and I tell people about $5,000 is a good place to start, which is good because typically that will give people about 2-3 months of an emergency fund in cash until they put it into an investment. Once they put it into an investment, it’s still liquid it’s just not as liquid as some kind of savings account. If anything were to happen while they’re working on their investment, it still has financial use as an emergency fund.

LS: Okay. You still want to play with the buy-low, sell-high though?

GH: Absolutely. Like I said, you still look for companies that are undervalued, that have good financials, that are selling options.

LS: In other words we’re selling options for the high price, not the low.

GH: Right. Right.

LS: What about growth stocks like Apple (AAPL) and Google (GOOG) and these?

GH: You can, but I don’t use them in my strategies except for a high-risk investment. Any company that doesn’t pay a dividend, I consider a high-risk. There’s more potential to lose money because if it goes down, there’s no way to recover those loses. In any portfolio, 70-80% should be core-focused on high-yeild, dividend-paying stocks that you can trade options on.

LS: Like Aflac (AFL)?

GH: Like Aflac (AFL) or Phillip Morris (PM) or AT&T (T) or Elie Lilly () or you know. . .

LS: Penny stocks.

GH: [laughs.] No. Not at all. The other 20-30% of your money should be 10-20% cash and 10% high-risk. And you can do anything you want with that 10% high-risk. Some people do like the penny stocks and want to hit the home run. Other people want covered calls without dividends. Other people will do uncovered calls or things like that. There’s a lot that you can do with that 10% high-risk to try and hit the home run. But 80% of the game is not home runs. 80% of the game is about the single to first. Getting on base. Making that money. Those home runs that you do get are gonna be great. They’re gonna be that exhilarating high of “YES! I DID IT! IT’S AWESOME!” That’s not the core of your portfolio. The core of your portfolio is 70-80% high-yeild, dividend-paying stocks that you can trade options on. 10% cash for down market opportunities where you can buy low. And the other 10% high-risk.

Join us next week for the final part of the Stock Options, Ask the Experts!