by Jim Pearce, http://www.investingdaily.com/
Investing Daily Article of the Week
The stock market has gotten shaky. After hitting an all-time high on July 29, the S&P 500 Index dropped nearly 6% over the next five trading days.
Please share this article – Go to very top of page, right hand side, for social media buttons.
On July 31, the Federal Reserve cut rates but hinted that it may not be willing to go as far as Wall Street would like. A few days later, the simmering trade standoff between the U.S. and China erupted into new hostilities.
Suddenly, talk of daily record highs for the major market indexes has been replaced by speculation that a correction is underway.
That being the case, you may be wondering if there is any way to make money in this market.
There is. In fact, I told you about it three weeks ago. At that time, Amazon.com (NSDQ: AMZN) was trading a little below $2,000. I opined:
“It appears to me that AMZN has entered into a trading range over the past 18 months of $1,500 – $2,000.”
I suggested the following course of action for Amazon shareholders looking to enhance their returns:
“If you own AMZN, now may be the right time to consider using an options strategy to enhance your returns, since there may not be much share price appreciation anytime soon. For example, a few days ago you could have sold a ‘covered call’ on Amazon with a strike price of $2,000 that expires in January 2020 for a premium of $165.”
Since then, AMZN has dropped below $1,800. On August 5, that same option could be bought back for twenty cents to close out the contract.
It’s Not Too Late
Think about that for a minute. Something you could have sold for $165 three weeks ago – if you followed my advice – is now selling for only twenty cents!
If you don’t own shares of Amazon, you may be thinking that it’s too late for you to join in the fun. Not so.
The psychology of the stock market is counterintuitive. Optimism is never higher than when something is as expensive as it’s ever been, and pessimism is at its worst when that same thing can be bought considerably cheaper.
Don’t ask me to explain it; I can’t. But what I can explain is how you can make money off of both extremes.
Now that Amazon has been discounted more than 10%, many investors fear it will go a lot lower. Even better, they are willing to pay you good money to carry that fear for them over the next five months.
A few days ago, while AMZN was trading near $1,750, you could have sold a “naked put” on it at a strike price of $1,700 that expires on January 17 for a premium of $106. After that, one of two scenarios will occur:
- If AMZN never trades below $1,700 between now and then, you get to keep the $106 with no further obligation.
- If AMZN closes below $1,700 by expiration, you will have to buy the stock at that price.
Either Way, You Win
Keep in mind, under either scenario you get to keep the $106 option premium regardless of which way the stock goes. That means your breakeven price if you have the stock put to you at $1,700 is only $1,594 because of the option premium you received.
What are the odds that AMZN will fall below $1,700 over the next five months? I have no idea. But at that price, it becomes a reasonably priced stock based on its sales growth and gradually expanding profit margin.
The way I see it, this a classic win-win situation.
Either you collect money now for doing absolutely nothing over the next five months, or you get paid to buy AMZN at a price it could be bought for more than a year ago.
And it’s not just Amazon. This type of market is ideal for selling naked puts against high-quality growth stocks. Option premiums soar when emotions are high on Wall Street.
That creates an opportunity for rational investors, especially when they use a proven system for profiting off the emotions of other investors.
Editor’s note: There is a risk involved in buying a stock as described by the author (or by using a limit order to buy only when the stock has fallen to or below a specific price): Ocassionally such a large price decline occurs as the early part of a much larger price collapse. In such an event, say AMZN moved rapidly down below $1500, a purchase at $1594 exposes you to a loss of at least $94. Thus, such a purchase strategy as outlined in this article requires careful diligence – or more complicated option strategies – to guard against large potential losses immediately in the event of a purchase in the middle of a stock price collapse. Such events may be rare, but they can only occur as part of the smaller price pullback this strategy is attempting to profit from. Trying to buy a stock in the middle of (i.e. attempting to “time” the bottom) is sometimes characterized as “trying to catch a falling knife”. Caveat emptor.
.
