While auto stock investors often wait for that ideal entry point, their cash can be found sitting in money market funds paying low yields. Alternate strategies all too often dismissed include: buying a closed-end money market fund at the right discount; looking to sell options as an income strategy; or simply buying put options to profit from that market ride down.
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With the markets in the U.S. closed today, it’s a good time to look again at strategies. Problem is, the average investor waiting to enter the market may not be aware there are more income strategies that just the average money market.
Just look at the chart here of the 30-Day Fed Fund Futures for Feb. 2012. That rising line shows a high price, but spells low interest rates, as the rates and price are inversely proportional. When bonds rise, for example, the rate falls; when bonds fall, the rates rise. So, what you have right now with Fed Fund rates are low paying money markets; and Bernanke has locked in to holding rates low.
Even if you're an investor who is somewhat aware and may consistently buy and reinvest dividends to enhance gains, and perhaps strives to hold stocks for the long haul, there still comes a time when stocks simply follow the general market down; and there seems very little you can do except to hold on for the ride if you’re already long the market.
That is why finding entry points at a bargain level gives you the ability to not only lock in an above-normal yields, but it provides an emotional cushion. And that's a great foundation while you wait to build a position in auto sector stocks (or any stock for that matter), even if that position is cash.
Stepping aside from specific auto sector stocks like GM, F or TM, for a moment, I refer to three income strategies while you wait for your target stocks to settle down enough to buy again for the next up-phase. These are: closed ended funds; selling upside call options; selling downside put options.
Now, be apprised I am not a financial advisor. So, my attempt here is to share my own experiences, and to merely educate and inform you of strategies that you may or may not have considered, especially after you take profits or losses on an auto stock speculation, or as you wait for the general market to settle down so as to buy again.
Point is, moving away from a stock position does not automatically mean you have to always accept any old cash entity, like a money market fund. There are other options, literally, that may make you income while you wait.
Money Market Funds
Realize there are two types of money market funds. Some are open ended; others are closed ended. Which should you buy? Well, that has to be your decision; and perhaps the advice of a financial counsel may be in order.
Just be aware that closed ended funds are still mutual funds, but are different in that they have a fixed amount of shares, unlike open-ended funds which create new shares all the time. Advantage is, the shares of closed-end funds can swagger from premium to discount.
Realize that buying into a closed ended mutual fund takes a greater degree of caution. Fact is, buying at a premium to its NAV or Net Asset Value can set you up for a drop. In this case, think of the probability of a reversion to its mean.
On the other hand, these closed ended funds often trade at discounts to their NAV. For example, when a fund trades at a 10% discount to its NAV, you are effectively buying a dollar's worth of assets for just 90 cents. If the portfolio's assets have an average yield of 5%, the discounted fund will then have a yield of 5.6%.
Selling Options for Income
This one takes a knowledge of options. So, I suggest not trying this strategy until you are educated and feel comfortable. In other words, do not buy or trade anything you do not understand.
However, selling options as a method to receiving income can be a wise move. For example, you can even do this with auto sector stocks. And now that weekly options are in play, the time decay in those options occur on a weekly basis, whereby monthly option decay is not as fast.
Say, for example, Ford, Toyota or GM stock was trading a bit too high for you to consider buying at today‘s price. So, rather than buying the stock at today’s price and hoping for the best, you could sell a put option at a strike price below the present stock price. You would immediately collect the premium as cash into your account. If the option expires out of the money, then you would keep the premium, and be able to repeat the event every month if you choose.
If the stock does go in the money where the stock trades below the strike price of the put option you sold, then you will likely have the stock put to you at the option expiration day; meaning, you would have to buy the stock at that strike price. Then again, recall you did want to buy the stock anyway.
So, while you were waiting for that lower price, you were literally paid to wait; and can apply that same premium you received toward your acquisition cost of the stock, thus buying the stock at the discount and establishing that lower price as your basis.
Selling Call Options for Income
This one especially takes a knowledge of options. First, you must own the stock. Then, if the stock looks to be going sideways and appears to have limited upside potential, perhaps sitting just below heavy resistance, then selling an upside call option as income will enable you to make money as income.
Say a stock you own was trading at 30 but looking weak. You could sell a 35 call option for income. If the stock rises above the call option by expiration, the stock will be called away, and you will have to sell the stock at the strike price. Then again, that is the gamble, but you made money, including income from the option.
Buying Put Options for a Ride Down
Sometimes, going to cash may be the best strategy for peace of mind, but it still does not make you much money in this low yield environment. Answer: going with the market, even if it is down, may be the better or more profitable choice.
This strategy here also takes a knowledge of options. Instead of selling put options or upside calls, you can buy a put option outright; in essence shorting the stock with a predefined risk. For example, say the auto sector runs into heavy resistance or the stock looks it might miss an earnings target, then buying a put option is one way to play it.
Let’s say when GM was sitting at 30 last year, you felt it was going to go down before it went up. Buying a put option would have made you money as the stock fell to the 19 level.
I personally prefer buying deep in the money put (ITM) options instead of the cheaper out-of-the money option (OTM) strikes. In the case of GM, a 32.5 or 35 strike would have been better than a 25 or 25 strike. Reason is, the ITM option responds faster to the stock price fluctuations. A cheaper, lower strike price may respond to less than 50% of the stock price changes, at least until it become at or in the money.
Final Comments
For the record, I have personally executed all of these strategies in the past; and will continue to do so whenever I see them as an advantage.
I notice, though, that Ford and GM stock premiums as of late are often cheap, which means the advantage of selling premium may not be there. The preferred strategy is to sell puts when volatility and option premiums are high, not low. However, buy a put or a call option, depending on whether you are long or short in your view, will cost you far less due to the lower volatility.
Are any of these strategies right for you? I do not know; only you can make that judgment; but be apprised that many traders use these strategies every month with great success.
Key to success, though, centers on educating yourself as to the advantages, disadvantages, as well as the timing and choice of option strikes and month of expiration. With regard to closed end funds, though, simply watch the funds for a discount to its NAV; otherwise, the typical money market fund may be all you have available.
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