The stock market appears to want to go higher, but it’s going to take a push by investors. While we could see the S&P 500 edge higher, I’m not convinced the gains will be that great unless the underlying stock market fundamentals improve.
I am talking about the economic renewal that appears to be stalling. The International Monetary Fund (IMF) slashed the country’s estimated gross domestic product (GDP) growth to an even two percent this year from the previous 2.8% in April. Growth in 2015 is expected to rise to three percent. These are OK numbers, but they’re not great and they indicate that the economy will likely struggle to find ground in the short-term. As far as the global economy goes, the World Bank cut its estimates, too.
Moreover, you also have the recent weaker-than-expected housing starts and building permits numbers. Both readings for May came in below both the estimates and the readings in April. The decline in building permits by 6.4% to below one million annualized units suggests there could be some stalling in the months ahead.
Geopolitically, you have the escalating conflict in Iraq and the continued standoff in Ukraine. Oil is above $107.00 a barrel and could head higher should the internal conflict escalate in Iraq and impact the flow of oil, which could affect global economic growth.
So here we have the stock market, namely the S&P 500 and the DOW, coming off record-highs.
If the stock market fails to find its footing (namely a fresh catalyst), we could see mixed and volatile trading in the months ahead as the stock market looks for direction. Moreover, if the stock market fails to get any positive leverage heading into the summer months, we could see some stalling in the stock market.
If the stock market stalls, an investment strategy you should consider is covered call options on your stocks or a market index to generate some premium income. This will allow you to make some money should your stocks sit idle due to a potential flat market.
For those of you not familiar with covered calls, the key is to make sure you own the underlying stock that you are writing the call on; otherwise, the position is “naked” and subject to significant risk.
The strike price you select should not be too close to the current stock price, otherwise you risk being called away. Of course, the higher the strike, the less the premium generated.
I suggest you choose the strike price based on the resistance levels of the stock on the chart.
To illustrate the concept of covered calls, let’s look at The Proctor & Gamble Company (NYSE/PG). Say you own 1,000 shares with the current price at $79.33 as of Wednesday. Now, say you believe the stock market and the stock will be flat over the next few quarters.
Assuming you are willing to sell the stock at $85.00, you can write the October $85.00 call option and bring in $0.46 per share in premium income. Should the stock fail to reach the strike by the expiry, the premium is yours to keep. However, if the stock reaches the strike price by the October 18 expiry, you simply have to deliver your stock at the strike price, but you would’ve made a nice return.
At the end of the day, with the stock market potentially stalling, writing covered call options makes good use of your assets.