An Investment Strategy for
When Markets Are Tanking
Monday, August 22nd, 2011
By George Leong, B.Comm. for Profit Confidential
The market panic is rising, as there is more speculation of another recession in Europe and perhaps in the U.S. Stocks plummeted over four percent on Thursday morning.
The current market bias is negative and my concern is that failure to edge higher could drive the index back lower or stall the trading.
Without leadership, markets are likely to stall or move lower to bear market status.
Should this happen, my investment guidance is to write some covered call options on some of your key long-term core holdings to generate premium income and reduce the average cost base of your positions. By doing this, the premium income added to dividend stocks could effectively increase the yield you can make from some of your dividend stocks.
However, be careful, as a market rally could take out your position at the call strike price, albeit the near term does not look promising given the death cross.
Make sure you are comfortable with the upper strike price of your covered call. Make sure it’s above the key resistance of the stock.
I have long favored the use of writing some covered call options on long positions should the market trade flat or down and when you want to hold stocks. This may be the case now.
Why let your positions sit idle? Write some covered calls to generate some premium income, increase your yield, and reduce your average cost base. It is simple to initiate. Just make sure you do not write a naked call (not holding the underlying stock); otherwise you’d be exposed to unnecessary risk and potentially extreme losses.
Let’s take a look at Cisco Systems, Inc. (NASDAQ/CSCO) and assume you own 100 shares at a cost base of $14.00 per share. You are already up $1.13 a share based on the current market price of $15.13 as of August 18.
Now say you continue to be long-term positive on Cisco, but at the same time feel that the stock may pause or move lower over the next quarter.
There are several strategies at your disposal. You can sit on the position and wait for the stock to rise. The problem is that this is an inefficient use of capital, in my view.
So why not make your capital work for you?
It’s much easier than you think and represents a win-win situation. The process involves writing covered calls on your holding of 100 shares of Cisco. For every board lot (100 shares) of Cisco, for example, one call option may be written.
If you think Cisco is dead money for the next several months, you can write an out-of-the-money November $18.00 covered call for premiums of $81.00 per contract, or $0.81 per share. If Cisco does not break above $18.00 by November 18, 2011, you keep the $0.81, which is a return of over five percent based on the prevailing $15.13 stock price.
Covered call writing is straightforward, low-risk, and a generator of premium income, as well as guaranteeing a selling price for the stock. Don’t write a covered call if you do not wish to lose the stock due to a possible exercise from the call holder.
So, if stocks stall, make some money and write some covered calls.
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Tags: bear market, covered call options, investment guidance, investment strategy, Market Veiw, technical analysis
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George is a Senior Editor at Lombardi Financial, and has been involved in analyzing the stock markets for two decades where he employs both fundamental and technical analysis. His overall market timing and trading knowledge is extensive in the areas of small-cap research and option trading. George is the editor of several of Lombardi’s popular financial newsletters, including The China Letter, Special Situations, and Obscene Profits, among others. His trading advice on stocks and options is also found on his daily trading site, Daily Profits. He has written technical and fundamental columns for numerous stock market news web sites, and he is the author of Quick Wealth Options Strategy and Mastering 7 Proven Options Strategies. Prior to starting with Lombardi Financial, George was employed as a financial analyst with Globe Information Services.
