Buying Stocks With A Twist

| November 16, 2011 | 0 Comments

The stock market is bouncing around like a Kangaroo on steroids.  Such heavy volatility can drive anyone to the brink of insanity.  You probably know exactly what I’m talking about.

But what can you do about it?  A growing number of investors think the best move is to sell stocks and buy bonds.  They believe this will lower their risk.

But, they’re dead wrong.

Before we go any further, let me be clear… bonds stink.

The one-year Treasury is trading under 1% and the ten-year treasury is under 2%.  That’s pathetic!  If you take inflation into account, Treasury investors are actually losing money on their “safe” investment.

Many other investors are using a ‘cash in the mattress’ strategy. Meaning, they’re hoarding cash in bank savings accounts.  I’m sure more than a few are even stuffing their mattresses with cash like in the Great Depression.

Boy, talk about earning nothing on your money.

Here’s a better idea… sell low yielding bonds and buy stocks instead.  Then add a “Twist” for even better yields.

I call this strategy, “Stocks with a Twist.”

Here’s how the strategy can work for you.

First, buy shares in a safe, defensive US stock with a strong balance sheet.  Make sure the company pays a high dividend yield and has a high credit rating.  You want to be confident in the company’s ability to keep paying their dividend.

Next, sell a leap call option on your stock.

A leap option is an option that expires twelve months out or longer. Because of the extended time frame, leap call options carry a much higher premium than shorter dated options.  In other words, you’ll put more money in your pocket by selling a leap call option.

Here’s the key…

You want to sell an at-the-money leap call option.  Why?  Because, you aren’t necessarily concerned with stock appreciation, just the large premium you collect on the option you sell and the dividends you’ll receive.

Ok, let’s take this strategy out for a ride with mega-cap drug maker, Merck (MRK).

Merck’s fundamentals are just what we’re looking for.  They have little debt and the company pays a $1.52 annual dividend per share… that works out to a hefty 4.2% yield.

What’s more, S&P has put a “AA” rating on Merck.  That’s just one notch below “AAA”, the highest credit rating available.

Getting back to our example…

Let’s say you buy 100 shares of Merck for $35 and sell one January 2013 $35 strike call option for $5.50.  The premium you receive from the sale of the call option is $550 ($5.50 per share times 100 shares). That’s just for starters.

Don’t forget, you’ll also collect hefty dividend payments along the way!

Since this strategy is stocks with a twist, it really doesn’t matter if Merck trades up, down, or sideways.  Even if the stock doesn’t appreciate, the “Twist” will generate a nice yield.  Meaning, more money in your pocket.

Here’s how rewarding this strategy can be…

Let’s say at expiration (January 19, 2013) Merck is still trading at $35. You collected $550 when you sold the leap option and dividend payments along the way totaling $190.

Now for some quick math… $550 in premium plus $190 in dividends for a total of $740.

Don’t look now, but you just earned 21% on your Merck shares.  And the stock didn’t go up in value at all.

You can’t get returns like this from a bank!

Bottom line…

Conventional bonds are yielding less than 2% annually right now.  To generate income, we’ve got to think outside the box.  My “Stocks with a Twist” strategy can be just as safe as a corporate bond.  And payout a higher yield!

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Category: Options Trading

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