Jun 19, 2010

The Current Market is Perfect for This

By Andrew Mickey, Q1 Publishing

When times are tough, this simple investment strategy works exceptionally well.

Right now times are tough.

Stocks, as a whole, are overvalued. They could move lower or higher. They’re stuck in the middle. Jeremy Grantham, of Grantham Mayo & Van Otterloo, summed it up well in his latest quarterly letter, “The global equity markets taken together are moderately overpriced, and the U.S. part is now very overpriced but not nearly so bad as it could be.”  Think: Too late to buy, too early to sell.

Bonds are yielding next to nothing. While the markets have rebounded in the last couple of weeks, bonds have too. The yield on the 10-year Treasury bond has fallen to a meager 3.22%.

And the economy shows no signs of genuinely rebounding. High unemployment is here to stay. Tax increases are just months away. And business investment, expansion and risk-taking are way down.

It’s a tough time for most investments. And that means it’s a great time for covered call writing - an investment strategy perfectly tailored for this type of market. And, if you’ve not too familiar with covered call writing, there’s a “no hassle” way to take advantage of it.

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Turning Volatility into Cash in Your Pocket

The markets have been in a rut for most of the year. The 2009 stock rally has run out of gas. We’ve entered a volatile market that, in the end, really ends up nowhere at all.

For example, this year the S&P 500 has fallen 10%, rose 20%, fallen 20%, and now is nearing another 10% rebound. Overall though, the markets have gone nowhere. The S&P is up 1% this year.

That volatility may be frustrating and nerve-racking, but it’s also immensely profitable thanks to the covered call strategy.

Covered Calls 101: The Best Investment for a Flat, Volatile Market

Covered call writing is one of the most basic option trading strategies. It entails buying a stock and writing (or selling) call options against the position. The call options give the holder of the contract the option to buy the stock from you at a predetermined price. In return for selling the upside potential the buyer of the option pays you the option “premium.”

We’re not going to get into all the details of covered call writing here (Investopedia has a full explanation here), but just know that covered call writing allows you to make money when stocks go up and are compensated to reduce downside risk.

For a market that’s shaping up to take a windy (read: volatile) path to nowhere, covered call writing is one of the best strategies to take advantage of it.

All the Benefits, None of the Hassle

One of the problems with covered call writing though is that it takes a lot of work. You have to research the stocks, trade the options, manage margin requirements, and do it all across a broad enough range of stocks to ensure you’re properly diversified.

It’s a lot of work most folks just don’t want to or don’t have the time to be hassled with it all.

That’s why we first looked into the “no-hassle” way of covered calls as a safe way to step into the market on March 5, 2009.

We noticed bearishness was getting a bit extreme. We wanted a lower-risk way to get in the markets.

So we explored covered call writing:

Covered call writing works well in a rising market. It doesn’t work in a rapidly falling market. It works great in a flat, highly volatile market.

During a highly volatile market, you’d get cash payments as high as 10% or 15% every month or two.

More importantly, we identified a covered call strategy ETF – where the pros do all the buying and selling across an entire index for you – as a quick, simple way to do it.

From Good to Great

That was a good time to do it.

The “no-hassle” covered call ETF we recommended was iPath CBOE S&P 500 BuyWrite Index (NYSE:BWV). It’s up 50% since then.

Here’s the thing, right now is a great time to do it.

The 2009 market rally was incredibly strong. Stocks were soaring. And when you’re using a strategy that intentionally reduces the total upside potential, you’re not going to be doing as well as you could have. After all, while the BWV rose 50%, the S&P 500 rose 65%.

Frankly, a 2009-like rally isn’t coming soon. After all, another 2009-like rally would put the Dow at 17,000. Not going to happen.  And that means now is a great time to look at covered call writing.

There’s Always a Strategy Working Somewhere

The Wall Street adage, there’s always a bull market somewhere, has certainly held true for a long time.

But rather than trying to guess the next big trend or hot stock, you can just take what the market gives you. Right now, the market is giving covered call writers a lot.

Covered call writing, however, is just one of the investment strategies which will work in a market like this. But it’s one of the best.

And that’s the bigger issue here. I can tell you now, most “buy and hope” investors won’t take advantage of it. They’ll simply right it off as too complicated and never even look into a “no hassle” way of doing in.

Frankly, in a market like the one we’re going to go through in the next decade, that is not an option.

The 70s were a “lost decade” for stocks. They went nowhere. The 2000s was another lost decade. The way things are shaping up, this decade will be lost as well. But there will be opportunities along the way and there will be great times for many investment strategies.

Now is the time to learn them.

Tomorrow we’ll look into another strategy, that’s safer and simpler than covered call writing and is, and will continue to, perform exceptionally well in the months and years ahead.

Does 108% in five months by without having to trade risky stock options sound interesting?

If so, we’ll look at it all tomorrow.

Good investing,

Andrew Mickey
Chief Investment Strategist, Q1 Publishing

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