Some people don't invest in the stock market because, they say, one can't predict where it will go or the value of any particular stock. I tend to agree with that, but it doesn't keep me from investing. While I don't pretend to be able to predict the price a stock will go to, or the market in general, I do think I can predict the likelihood of a stock within a range over a short time frame. And that's enough to make money in the market.
For example, while I think Apple stock will go up and down during the rest of this year, I don't think it will fall more than 10 percent in any 60-day period. In other words, if we look at the next three 60-day periods, I don't think that the stock will fall more than 10 percent during more than one of those periods.
The fact is I don't actually think Apple stock will fall more than 10 percent in any of those three 60-day periods because I think we have just begun to see the tablet revolution, and Apple TV devices, which have barely started to be distributed, are going to be the next big hit for the company.
"If I were a rich man'" as the song goes, I might buy 1,000 shares of Apple stock. But $600,000 is too much for me to invest in one stock, particularly one that doesn't pay much of a dividend. Or maybe not: Apple stock has already moved up a lot based on future predictions, and I feel more confident about it not moving down than I do about it continuing to move up. So based on my prediction of statistical likelihood, I sell puts on the stock.
The last round of puts I sold on this stock were the July 530s. In other words, I was betting that the stock would not go below $530 (or I would be contractually obligated to buy 1,000 shares at that price, which, if I did, I would have sold the same day even if it were below $530 and I had to take a loss). For 10 puts I received $30,000.
It would be nice if I could keep all of that, but in fact I usually hedge my risks by buying puts at a lower price to protect me against a catastrophic loss. So here I bought 10 puts at a strike price of $515 and paid out $22,000. In fact, Apple stock went up a bit, so my profit for this 60-day period will be $8,000. My risk was limited to $7,000 (15 points less the premium).
Here are a few other predictions I am currently following in my account:
•I think Bank of America stock (BAC) will go up to over $8 a share by the end of the year. I am selling the $8 puts based on this prediction. Yes I realize that financials and banks have not done well, but the stock seems oversold to me for its potential. This is called an "in-the-money" put, which is a way to benefit if a stock goes up in price. Note that this is different from the other examples here, which are betting that stock will not go down below a certain level.
• Based on the research done by a friend who shared it with me, I have accepted his prediction that Green Mountain Coffee Roaster (GMCR) stock will not go below $20 a share. At the moment I have sold the September 20s, taking in a $2,100 premium. The stock dropped from over $90 a share down to the low 20s, and we think this is an over-reaction for a company in the coffee industry that has a good customer base.
• JP Morgan (JPM) stock was hit with unexpected trading losses, and the market reacted. But when I looked at it I noticed that in spite of billion-dollar losses, current profits remain higher than the losses. So again I felt that the market overreacted. I sold the July 30 puts and took in a $1,600 premium. Since I placed that trade the stock has moved up in my favor.
• I've been consistently writing puts on Unilever (UN) based on my assumption that the stock will go over $35 a share. It seems like a good stock that pays a handsome dividend, and if I have to buy it that's OK. So far my prediction has been wrong, and the stock has stayed between $33-$34 a share. But the premiums have been just about the same as the losses, so I've only lost a small amount during the past three quarters. I am continuing with the same prediction.
• When Walmart stock was around $58 a share it looked like a good investment, so I sold 10 puts at a strike price of $55, and bought the 45s as a hedge, taking in a net premium of about $800 due in September. Yes it appears that I made a profit, but I would have made a lot more had I just bought some of the stock. The stock has moved way up and is currently trading at around $73 a share. One of the negatives about writing puts is that you don't participate in the big hits!
• Some of you might have noticed that all of these predictions concerned upward price movements. None of them were predictions benefiting from the likelihood of a downward movement in price. That's true. Since the beginning of 2012 I've been generally bullish on the market, and felt that prices of good stocks in general will go up during the year. Also, put premiums have been greater than call premiums. But I do sell calls, based on a likelihood of a decline in price, and perhaps in my next article I can talk about that.
For information about Merv Hecht and more details on the strategies and stocks he writes about in this column, visit his website at DoubleYourYield.com.
