A Bargain-Hunting Strategy for an Extra Discount
The final week of February was certainly one to remember. Not in a good way.
The S&P 500 last week experienced its fastest correction in history. Never before had the S&P 500 take only six days to lose 10% or more. As of Friday, February 28, the S&P ended trading down 12.8% from its all-time closing high just 7 trading days ago.
While the coronavirus (dubbed COVID-19) has been in the news for many weeks, the market shrugged it off. But once the number of cases and deaths started to jump overseas in countries like Italy and Iran, the market went far the other way.
Staying Calm in the Face of Fear
Greed lifts up the market and fear hammers it down. When fear takes over, the market tends to fall much faster than it went up, as we saw last week.
When the market drops like that, it’s frightening. People’s hard-earned money is going up in smoke.
But it’s important to keep perspective. The market is falling in a way it hasn’t since the Financial Crisis. However, we are not facing a financial crisis.
Think back to the dark days of 2008-2009. It felt as if the pillars of capitalism might collapse. However, the markets and economy recovered.
The people who lost money were the ones who sold, ran for the sidelines, and didn’t come back. People who stayed invested made back their money and then some.
Rational Thinking Is Key
When it comes to investing, emotions can be our worst enemy. It’s not easy to make rational decisions when our investments are sinking day after day. But we have to keep an eye on the big picture. The market has always rebounded from previous drops. Things are painful now for investors, but it will get better.
It’s fine to sell some of one’s riskiest stocks until there’s more clarity into the extent of the outbreak, but it would be a mistake to sell indiscriminately.
That’s why it’s important to have a diversified portfolio of quality stocks. No matter how much they might fall as a result of the widespread sell off, if the company is good, the stock will rebound.
A Way to Make Extra Cash
During times like this, one way to make a little extra cash is to write (sell) put options.
When stocks are falling, the price of the options (the option premiums) will rise. In other words, if you are selling puts, you will get a better price when the underlying stock is falling.
This strategy works especially well if you are a bargain hunter. If you like a stock, and you plan to buy it if it falls to a certain price anyway, selling a put will give you a little extra money. It reduces your cost basis and works effectively as a discount.
How It Would Work
For example, let’s say you’ve been watching Cisco (NSDQ: CSCO) for a while, but the stock rose as high as $50. You like CSCO and you want to buy 100 shares if it falls to $40.
Last Friday, CSCO fell below the $40 mark so you could have pulled the trigger. However, instead of straight out buying it, you decide to sell an April 17, 2020 $40 put against the stock.
Based on real-time quotes, you could get $3.05. If you sell 1 contract, that’s $305. Nowadays, the commission should be under $1, so you will net more than $300.
Some Thing to Keep in Mind
There are possible drawbacks to this bargain-hunting strategy.
If CSCO falls below $37 and the option is exercised, you would start off underwater. You had to buy at $40 even though you could have bought it for under $37 on the market. The ~$300 premium you collected offsets your cost, so if the option had been exercised when CSCO is between $40 and $37, you would have still started with a profit.
But since you would have bought the stock at $40 anyway, you would have been in the same situation, AND you would not have the premium to offset your cost. This is why it’s important to pick a stock you like and a strike price at which you would be comfortable buying the stock.
Another drawback is that depending on how much money you are working with, selling a put on a high-priced stock may not be realistic. For example, 100 shares of Amazon (NSDQ: AMZN) would cost six figures and wouldn’t work for the bargain hunter using the put-selling strategy. Most individual investors wouldn’t be able to buy 100 shares of Amazon.
This put-selling strategy is just one way to weather the market downturn. Another is increasing your exposure to gold. My colleague Dr. Stephen Leeb has pinpointed an under-the-radar play in gold that the rest of the herd is missing.
Gold is the classic safe haven during tumultuous times. As coronavirus panic grips Wall Street, gold prices have been soaring, with further to run.
Dr. Leeb is chief investment strategist of the premium trading service, The Complete Investor. I work closely with him on the publication. His latest play on the “Midas metal” could hand you exponential gains…if you act now. Click here for details.