Many investors are finding this market extremely difficult to trade. There is increasing volatility in both directions but no real directional bias since March. In fact, the stock market barometer of the Dow Jones Industrial Average hasn’t moved out of a 650-point channel over the last four months.
Most things are looking very bullish in the economy, and the stock market should be taking off to the upside. However, bearish international pressure combined with domestic interest rate fears have put a lid on the stock market bulls.
Both the traditionally bullish and bearish stock market experts are giving mixed signals about what they forecast for the near future. To say it bluntly, the market is confused right now.
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The good news is that most stock investors are sitting on solid profits from the last several years. The major indexes have skyrocketed higher due to the very stock positive environment.
The bad news is that it looks like the gravy train may be soon ending. Now, I am certainly not calling for any stock crash or sharp selloff anytime soon. Interestingly, it appears that both the bullish and bearish expected future news is already baked into the stock market price. As you know, the stock market is an anticipatory mechanism. This means that its movements are based on what it anticipates is going to happen more than what occurs. Right now, it is expecting higher rates yet prices are staying relatively flat.
What Does All This Mean For My Portfolio?
Stating it simply, the stock market will likely remain within a relatively tight range for the rest of the year. This means that the outsized gains experienced over the last several years will likely end. While no one knows for certain what the future holds, the above scenario is certainly the most likely.
Does this infer that you should sell your stocks and immediately go to an all cash position?
No! However, it does mean that investors should start to explore other ways to generate returns from their stock market portfolios.
Believe it or not, there are several time-proven tactics to turn your stocks in cash generating machines.
These tactics work particularly well with stocks and indexes that are relatively flat or trading in a tight range.
Cash Generating Strategy # 1
The first cash-generating tactic to implement is the covered call strategy. Most investors view this approach as a way to protect gains. However, it also works as an efficient profit creating tactic. Let me explain.
What Is Covered Call Writing?
Covered call writing is another term for covered call selling. In the options world, writing means selling.
Remember that one call option affords the buyer the right to buy one hundred shares for a particular price during a pre-determined time frame. By writing (selling) the call option, you are selling the right to the buyer to purchase one hundred shares of stock from you at the agreed upon price. This price is named the strike price.
The majority of options are known as monthly options. This means that they expire on a monthly basis. However, there is a newer form of an option called weekly options. These options expire on a weekly basis.
For every one hundred shares of stock, covered call writers sell one call option. The call is called “covered” since you already own the stock.
Being covered significantly lessens risk when compared to “naked” call writing.
Naked means are selling calls without owning the stock first. This can be perilous when selling call options.
The selling of the call generates income; this income can be substantial when covered calls are done on a rolling basis. This income is what will help increase your returns during flat or slowly dropping markets.
Let’s make-believe the call option you sold against 100 shares of stock was worth $4.00. Since the call denotes one hundred shares of stock, you will instantly receive $400 minus commissions and fees in your account. Just imagine how this simple strategy can ramp up your returns!
WHAT’S THE CATCH?
If you are anything like me, you think that this seems too good to be true and what’s the catch.
Well, there isn’t any catch. However, it is critical to know that by selling the call, you are obligating yourself to sell your one hundred shares of stock at the strike price of the call. This means the buyer can purchase your one hundred shares at any period during the life-span of the call at the exact strike price.
If the purchaser decides to buy your shares at the agreed upon price, this occurrence is known as exercising the option. If the price of the underlying instrument (stock) climbs above the strike price of the option, it is likely that you will be forced to sell your shares to the option buyer.
This will limit your upside gains radically. At the same time, within a slowly advancing, neutral or falling stock, covered calls will beef up your return during the same period. Stating it bluntly, covered calls can offset downside risk due to the premium received or add to upside gains.
A smart way to think about it is that you are obtaining immediate cash in trade for any increases greater than the strike price of the call option.
Cash Generating Strategy #2
The next cash-generating strategy is called naked put writing. As you know, writing means selling in the options world. While writing naked calls can be perilous, writing naked puts has a much lower risk profile. In fact, writing puts has the same risk factors as covered call writing.
Writing naked puts is also known as the “short put strategy”. The primary risk of the strategy is that you may end up being forced to buy the stock directly at the strike price of the put. This is why your broker will likely require you to have the available cash/margin to buy 100 shares of the particular stock at the strike price per put that you sell.
The best line of attack for naked put writing is only to write puts on stocks you wouldn’t mind owning at the strike price. Approaching this cash-generating technique in this manner makes it an almost no lose proposition.
If you are forced to purchase the shares, you are buying them at a price you already believe is a good price. If you do not have to buy the shares, you get to keep the premium paid for the option. It’s truly a win-win situation.
The Key Takeaway
The stock market has been volatile but trading in a tight range recently. Many experts believe that stocks will likely go flat rather than plunge or soar in value until at least the end of the year.
Investors can continue to generate cash in their portfolio by utilizing several strategies.
The first one is covered call writing. This means selling calls to collect the premium against stock that you already own.
The second method is writing naked puts. Naked put writing has the same risk profile of covered calls but does not require you actually to own the stock first.
Both of these tactics are time proven ways to turn your portfolio into a cash generating machine in flat or slowly falling markets.