For decades, stock market participants have been led to believe that “investing” is safe… while “trading” is risky. But the way most people “invest” is about the riskiest way you could possibly manage your money. The prevailing advice has been something like this:
“Diversify your investments. Buy quality companies and hold them until you retire. Whether it is stocks or real estate, the values always go up over time.”
That is… until they don’t.
The past two years have shown us how unwise (and unsafe) that advice really is. Diversification helps very little when everything is falling. And while real estate and the markets generally do rise over the long term, that is not much consolation if your retirement is five years away. Millions of people have paid for these misconceptions with huge losses in a short period of time.
Michael Covel, the author of Trend Following: Learn to Make Millions in Up or Down Markets, points out some major pitfalls of the “investing” mindset:
“Investors put their money, or capital, into a market, such as stocks or real estate, under the assumption that the value will always increase over time. Investors typically do not have a plan for when their investment value decreases. They usually hold on to their investment, hoping that the value will reverse itself and go back up. Investors typically succeed in bull markets and lose in bear markets.”
Most investors have no idea how to respond to or, better yet, how to capitalize on a falling market. Clinging to the idea that the markets “always rise over time,” they “hang on” and continue to lose.
If you have any money in the markets – even if it is just your 401(k) – you need to begin thinking of yourself as a trader. That doesn’t mean you have to buy and sell stocks every day, or even every month. But it does mean having a selling strategy for when the market goes against you. It should also mean having a strategy to make money when the markets rise… and when they fall.
There is no doubt that we are in the worst economy in decades. Corporate earnings are falling. Unemployment is rising. And while the stock market recently experienced its sharpest rise since 1933, the overall trend is still down.
But what is bad for the economy and terrible for the market does not have to wreak havoc on your investments. By employing the right strategies, you can multiply your wealth safely in just about any market. In fact, there are a number of strategies that have never been as safe or as profitable as they are today.
Here are two that you should consider right now:
1. Selling Covered Call Options
Selling (or “writing”) covered calls is one of the safest ways to generate extra income from the stocks in your portfolio. And due to the volatility in today’s market, option premiums are currently much higher than their historical averages. As a “seller” of options, that works in your favor. This is a strategy that could easily and safely generate 20 percent annual income for you.
Selling covered calls is probably the lowest-risk form of options trading. It involves selling someone the right to buy a stock that you own at some time in the future. For this privilege, the option buyer pays you cash up front, thus lowering your cost basis for the shares you’ve purchased.
Here’s how it works…
Let’s assume you own 100 shares of stock ABC. The stock is trading for $10 and the July call options on it – with a “strike” price of $11 – are selling for $1. So by selling one call option on your 100 shares of ABC (each call option represents 100 shares), you immediately receive $100 in your account. Therefore, your cost basis on this transaction is $900 ($1,000 – $100).
There are three possible outcomes to this trade:
• If ABC is trading for more than $11 before the option expiration date, the buyer would exercise his right to purchase the 100 shares of stock from you for $1,100. (He would then turn around and sell those shares, making a quick profit.) In this case, you would make 22 percent, based on your cost basis of $900.
• If ABC is trading for less than $11 but more than $9 at the expiration date, you would still own the shares – at a gain – and you would pocket the cash you received up front. You could then repeat the process to generate another round of income.
• If ABC is trading for less than $9 at expiration, you would be holding your shares at a loss. But the income you received up front by selling the call option would offset that loss. And, again, you could repeat the process to recoup more of the loss and generate additional income.
The key to this strategy is to use it with stocks that you would like to hold for the long term. They could be stocks you already own or stocks you buy specifically for the purpose of writing covered call options – stocks you believe to be very safe and cheap. And you should employ this strategy at a time when option premiums are large – as they are now. Ideally, you will be selling options that expire within three to five months.
By writing covered calls on high-quality dividend-paying stocks, you can get an extra bonus. Best-case scenario, you keep the option premiums, you keep the dividends, and you keep the stock too!
2. Selling Put Options
Selling puts is a strategy that can generate an annualized yield in the neighborhood of 30 percent to 50 percent. When executed properly, this strategy can be highly profitable and carry very low risk. That is especially true in the kind of market we have today, where fear is high and option prices are elevated.
This is a great way to buy stocks at a discount. Let’s say you would love to buy IBM at $81 a share, but it’s selling at $89 a share. In this case, you could sell the $81 put option. If the price falls below $81 before the option expiration date, you get your shares at the price you like. If the price stays above $81, you keep the premium and you can repeat the process.
You can also sell puts with the goal of generating income. In this case, you’d want the puts to expire worthless so you can capture the option premium. To accomplish this goal, you sell puts that are “out of the money” on stocks you believe to have very little downside risk… and which you would be willing to purchase at a much lower price.
Here is an example…
Let’s assume that stock XYZ is selling for $13. We’ll also assume the stock has already fallen by a significant amount (not too hard to find in today’s market) and you believe the rock bottom liquidation value of the company is $8.
With the stock trading at $13, the July $10 put option is well out of the money and selling for $1.50. You decide to sell those puts. When the trade closes, $150 will automatically show up in your account for every put contract you sold.
The only way you could lose money on this trade is if XYZ trades below $8.50 ($10 minus $1.50) on or before the option expiration date in July. That would be a 35 percent drop from the depressed level the stock is trading at when you sell the puts.
And in the unlikely event that you are obligated to purchase those shares below $8.50, you should still come out okay. After all, the liquidation value of the company is $8 a share, which makes the downside risk very small.
This strategy should be employed on stocks where you believe the downside risk is minimal. And you should only employ it on stocks that you would be glad to own at a price below where you sell the put.
You should also have a reasonable understanding of the true valuation of the company. For this reason, I would exclude most financial and insurance companies, as few people (including insiders) have any idea how much these companies are worth or what is on the books.
By selling put options, you could buy super-high-quality stocks as much as 50 percent cheaper than today’s historically low prices. Plus, you’ll get cold, hard cash deposited in your account instantly… adding to your annual income!
Where You Can Learn These Strategies… and a Lot More!
By no means are these the only strategies that can be highly profitable in today’s market. We are also seeing a once-in-a-generation opportunity in high-quality corporate bonds. Invest in the right ones and you can enjoy significant capital gains plus income… without taking stock market risk.
This is also an excellent market for shorting stocks. But you should not just go out and short any stock. The inevitable bear market rallies could put you in the poorhouse. The lowest risk opportunity is to short those stocks that are almost certainly going to zero – companies with an impaired business model and a massive debt load. There are dozens, if not hundreds, of them out there.
The good news is that putting these strategies into action can be a lot simpler than you may think. The better news: You don’t have to do it on your own…
Nine top investment experts have been asked by Investor’s Daily Edge and Mt. Vernon Research to share their number one strategies and top recommendations that are making a fortune in today’s market. It will take place in June, at the Turnberry Isle Resort & Club in Miami.