Monday, May 4, 2009

7,000 Points to Go, and That's the Good News

By Steve McDonald

For months, my colleagues and I at ETR's sister newsletter, Investor's Daily Edge, have been pounding the table about how this market is a stock picker's dream. We have said things like, "Millionaires are made at this point in the market cycle," "Stocks are really cheap," and "Build a bulletproof portfolio now." But most people can only hear the doom and gloom news, and it always ends up costing them money.

The market is almost 7,000 points below its previous high, even after a huge move in the last month. This is a buy signal... not a reason to stay out. But most will stay on the sidelines and wait for stocks to become overpriced before they buy again.

In my last ETR article, I said that you can lower your risk in this market by giving it time. Now, here's another suggestion...

Average in, rather than dumping in all your money at once. Buy about one-quarter to one-third of what your usual position size is, and buy on the dips - and there will be dips in the next three to five years.

If you want to add a nice kicker to this plan, buy companies with good dividends. That could add 5 to 7 percent to your annual return. That's how cheap stocks are right now. Companies that usually have dividends of 1 to 3 percent are paying 5 to 7 percent.

This is a 100-year buying opportunity. The only requirement is that you must be willing to stay the course and treat selling dips as buying opportunities. You have your pick of the best companies in the world right now at bargain basement prices.

[Ed. Note: Get the scoop on more emerging investment opportunities from Steve McDonald in Investor's Daily Edge, ETR's sister publication. Sign up for free right here.

Larry Potter

Saturday, May 2, 2009

Financial Wizards

Since last fall, our financial wizards have promised $12.8 trillion in bailout funds to primarily well connected cronies. The US national debt since the birth of this great nation now stands at a comparable $11 trillion. None of these debts will ever be paid off and it’s hard to fathom how anyone believes to the contrary.

The printing press is also being used to artificially maintain low interest rates via market interventions. Derivatives have long been focused there but now the Fed has resorted to direct action. The Fed is in the market buying our own Treasury Bonds. $300 billion is the first estimate, but you know how government estimates tend to work out.

Folks, this extreme action is akin to entering the bidding for your own house sale. An advanced central planning degree is required for this desperate maneuver.

Larry Potter

Friday, May 1, 2009

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!

Larry Potter