buy-sell-hold-die.jpgIf this market hasn’t convinced you that buy and hold is a gamble- I don’t know what will.

Holding any stock for more than a day has been a sure recipe for heartache (sometimes just an hour will do it) but we have been having a good time at PSW, during our member sessions,bottom fishing andconcentrating on plays that give us much better prices than the ones paid by the average retail investor using very basic option strategies.This strategy, which we call a “buy/write”, as we buy the stock and write options against it, is one of our most effective tools for dealing with a choppy market.

There are, of course, many, many stocks tradingnear multi-year lows and it’s still important to select ones that have strong underlying fundamentals that we actually don’t mind holding long-term but, as long as you are willing to own200 shares of a stock – this system can reliably give you a 10-20% discount off the current market price. It’s simple, easy to follow and is ideal for trading in a volatile market.

Of course when we buy any stock or long-term option position, we should be scaling in. In other words – we don’t assume our timing is perfect and we enter a position in stages. In our Strategy Section I discuss the 20% entries and the various rules for that so I won’t get into it here but, effectively, selling puts and calls against a stock entry is a way of automatically following the scaling system without having to monitor your position that closely. I will give a few examples here and, if you sign up for our newsletter service, PSW REPORTS, using this link, we will be waiving the fee during a trial period and there will be follow-up trades each week throughJune options expiration (19th).

imageloader.html?isbn=1576602494&size=T&Let’ssay, for our firstexample,we want to buyBAC at $8.26. If our goal is to buy 200 shares we buy instead 100 shares and also sell the June$8 puts for $1.65. Additionally, we sell theJune$8 calls for $1.77. The two sold contracts reduce our net basis to just $4.84 and we have taken on two obligations. The call we sold, obligates us to sell our stock for $8 on June19th IF the price ofBAC closes above $8 on June 19th – we have sold someone an OPTION TO BUY our stock for $8 on that date for $1.77, which we keep, whether they exercise the option or not. Our second obligation is on the put we sold. By accepting money for the put, we have agreed that, in exchange for $1.65,the put holder can “put” the stock to us (force us to buy it from them)for $8. They can do this at any time prior to Dec 20th, no matter what the price of the stock but, of course, if the stockstays over $8, there would be no point for them to put it to us at a discount.

So, ifBAC finishes the expiration period above $8, we will have our 100 shares called away at $8 and our put holder will expire worthless. The profit on that trade would be $3.16per share against our net outlay of $4.84, a 65% profit in8 weeks. Should, on the other hand,the stock be put to us below $8, then our caller would be expiring worthless but we will be forced to pay $8 for 100 additional shares of BAC, regardless of what price it’s currently trading at. With our original 100 shares at net $4.84 and 100 more at $8, our new net basis would be $6.42 – which is 22.3% lower than the current price.

This is a simple example over a short period. The key is to pick stocks that are:

  1. Trading near lows
  2. Fairly volatile
  3. NOT likely to go bankrupt/Undervalued
  4. Either pay dividends or have good growth
  5. Have a clear path of continuing contracts to write
  6. You don’t mind owning long-term

In short, if you think BAC is near a bottom at $8.26- why not commit to buying it for $6.42 instead? Also, to take a more advanced view, the trade doesn’t end onJune 19th. You have a $6.42 basis in Bank of America, who may or may not continue to pay a .16 annualdividend. If they do, that’s another2.5%return on your money. Additionally, you can continue to sell calls against the stock. Let’s say BAC falls all the way to $5 and you are stuck in it at $6.42. You can still sell $7.50 calls for .10 or more. While this is not absolute, I can see that theMay$12.50 calls, which are $4.24 out of the money are selling for .12 so it’s not a big stretch to assume we can pick up a dime for the $7.50s if BAC dips to $5.

091504Addn20Sale_07.gifWith a basis of $6.42, we don’t mind being called away at $7.50(up 17%)and, if we sell just .10 12 times during the year, that’s an ADDITIONAL $1.20 return per share or a18.7% return on our $6.42 investmentwhilewe wait (profitably)for BAC to come back in value.

Also, these plays are not static at all! We just did a similar play on LVSTuesday afternoon, buying the stock for $5 and sellingthe May $5calls for .80and the May $5 puts .85. That made his net basis $3.55 (a 33% discount offthe price at the time!). Had the stock gone down, we would have had anaverage entry of$4.28, 14.5% lower than the $5 entry. LVS shot up to $5.63 today, making the trade look very safe and the puts we sold fell to .57 while the calls climbed to $1.20. That gives us a current net of $3.86, alreay .31 higher than yesterday (up 8.7%). We are not forced to wait for May 15th, we can close out the trade now for a nice one-day profit by simply buying back the puts and calls and selling the stock or we can ROLL the puts and calls. That just means buying out the current set for $1.77 and then selling a different set of puts and calls at a more advantageous position.

If we were gung-ho bullish that LVS was heading higher, we could trade our $1.77 May $5 puts and calls for the June $5 puts at $1 and the June $6 calls at $1.60. That actually puts another .83 in our pocket (the netcredit fromthe roll) and LOWERS our basis to $2.72 AND RAISES the amount at which we’d be called away from $5 to $6. It’s a win/win/win for us – it’s like a magic trick! If LVS does finish June 19th over $6, we are given $6 for our stock, the puts expire worthless (we keep the money) and the trade closes with a $3.28 profit (up 120% in 8 weeks). If the stock is put to us below $5, our net entry is $3.86the average ofthe $5 we pay for more shares and the $2.72 we paid for the first round or $3.88, 22.5% below our $5 entry!

strategy.jpgAt this point you may be saying to yourself: “If I can learn to buy all my stocks for 22.5% discounts, I bet I can improve my trading performance.” That’sexactly what hedge funds do and there’s no reason you can’t learn to do it as well! The great thing is – there is always an option.

What if the stock goes down -you may wonder? As we mentioned, if LVS falls to $3 on option expiration day, you are still (assuming you make no adjustment) obligated to buy another round at $5. Your average entry would be $3.86 but, guess what? You can do it all over again and give yourself another 20% discount, dropping your basis to $3.20 or lower. Of course you may end up with 400 shares at $3.20 but, since you started out willing to buy 200 shares at $5 ($1,000) and you ended up with 400 shares at $3.20 ($1,280) with the stock at $3 ($1,200) you are down just $80 (7%), not bad for a stock that fell 40% since you first bought it!

We have featured over 100 of these plays in the past month in memberchatand on ourBuy List and, in this scary and volatile market, they are one of the best ways for youto capitalize on the volatility while hedgingthe risk on your upside playsand positioning yourself for a (we hope!) recovery. If the market does end up flatlining however, we are positioning ourselves in stocks at good prices that can generate a very reasonable monthly income – which will keep us flexible in a challenging market!

Again,if you sign up for our newsletter service, PSW REPORTS, using this link, we will be waiving the fee during a trial period and there will be follow-up trades each week throughJune options expiration (19th).