Many investors are afraid to go into the stock market today because of the extreme volatility. From day to day the Dow Jones and other indices suddenly are moving up and down in unusual swings.
But what many do not realize is that this psychologically-driven market often creates a buying opportunity.
For example: Whirlpool (WHR) is one of the leading companies in the United States, and has been in business since 1898. Whirlpool Corporation engages in the manufacture and marketing of home appliances worldwide.
A few weeks ago when the company announced that earnings were down and they would be laying off some staff, the stock dropped precipitously from about $65 a share to about $50 a share. Recently, since I started writing this article, it has started to move back up.
At $50 a share the annual dividend is over 4 percent! While it is possible that the dividend will be reduced, there has been no such suggestion from the company. And it seems more likely that after cost cutting efforts and a return to a more normal economy, customers will be buying refrigerators and dishwashers — all over the world — and the profits will come back up. Meanwhile, 4 percent is not a bad return in today’s financial world.
Personally I’m an option writer. So when an opportunity like this arises I either sell 10 puts at 50, collecting in a $3,000 premium, or buy the stock and sell calls against it, taking in about 12 percent a year in returns between the call premiums and the dividend.
(Addendum: Whirlpool stock announced record earnings last week and the stock jumped from $55 a share to $68! For those that took my advice (originally on my website about one month ago) this was good news. For those that wrote covered calls against the stock at $60, they picked up the option premium plus $5 a share — not bad, but they left a lot on the table. For pure option writers it was a bitter pill.)
Better to have options
Why do I like options? Because by writing calls against my stocks, I sometimes make a profit even when I pick a dog.
One of the worst performing stocks I bought in 2011 was TEVA. But it’s been a good source of call premium income, and now has started to move up toward my purchase price of $45.
I have been holding the March 42.50 calls for which I received $1,300 when I sold the calls.
Last week the stock went over $42.50. I decided not to let it be called away.
So I bought back the March $42.50 calls and paid $2,765. At the same time I sold the June $45 calls and took in $2,275.
In other words, I gave back $500 in cash of the original premium I had received in order to move up 2 1/2 points (or $2,500 on my 1,000 shares). From a tax point of view I have a loss ($2,765 less $1,300) so far. If the stock doesn’t go over $45 in the next six months I will still have a profit on the options.
That doesn’t look likely with the stock now at $44.50 and the market looking hot. But if the stock goes to $45, which was my cost, I can let it be called away, receive my $45 cost, and come out way ahead from the option premiums.
My point is that by writing calls against my stocks, I sometimes make a profit even on those stocks that temporarily go down in value after I buy them. And sometimes even if they stay down.
Another way to buy stocks is to look for a promising technology. I recently read an article about Nuance Communications, Inc. (NUAN). This is the leading company in voice recognition technology. This technology seems to be a very hot area.
When, through research, I discovered that the company has a contract with IBM to joint venture the technology, I recommended the stock on my website. That was in December, when the stock was trading at about $24. Personally I wrote a naked put at $21 a share, and took in a premium of over $1,100. By doing that I agreed to buy the stock if it went down to $21 a share. Of course even if it did go down that much, over 10 percent, I would have been OK to buy the stock at that price, reduced even more by the cash premium I had already received.
The stock has now moved up to $28 a share. For those that bought the stock, their investment has gone up 20 percent. For humble option writers like me, I am ahead only 10 percent. But I have to wait until April until my potential obligation expires.
For information about Merv Hecht and more details on the strategies and stocks he writes about in this column, visit his web site at DoubleYourYield.com. Look for his financial column to begin appearing regularly on Mondays.