My Strategy Explained

My Strategy Explained

Foundation Of My Strategy:

I believe that no one can forecast with accuracy the direction of stocks and markets more than a day or two in advance. We can tell when a bear market is upon us and when a bull market has returned. Gurus will tell us that the market over time always goes higher and that stocks always move higher, eventually. I once owned stock from past years that not only did not ever recover but collapsed and some disappeared all together. While it is true that I can write off my capital losses, I find it small consolation that I can write off my losses against my gains.

What also bothers me is that when a stock is rising, not one adviser can tell you when to sell. Instead they say “overweight” or “underweight” or use “tight stops” or “stop losses”and such jargon.

The Learning Process:

In the end I cashed out of the market all together and put my capital into a direct deposit for 1 year.

Then I read every book on investing I could find and sought out a mentor. The mentor explained that the secret to investing and growing my money was to earn small monthly amounts through options on large cap companies that paid a dividend, had strong balance sheets, good growth prospects and had options available. He showed me his portfolio going back to 1932. His portfolio gains were impressive, not because they were large but because they consistently averaged between 10% to 18% a year, every year.

He explained that it is necessary to set goals and have a plan. Through having a plan, emotion is greatly reduced from the trade, which reduced the chance of my making a poor decision in the heat of a sell off or a panic in stocks.

Ny mentor showed me that while buy and hold was probably a viable method of investing, that it was better to own the stocks through selling options to gain additional capital which would help pay for these stocks. The concept was to earn enough from selling options to eventually own the stocks without actually using my own capital. Then once I had made enough capital to pay for the stock, to then sell out of the money covered calls to not only earn the dividend, but to increase the dividend being paid through more income in the covered call. Then once the stock was exercised from me through the covered call, to repeat the cycle and start again:

So the investing cycle became:

Sell put options to gain captal.
Earn enough capital to pay for the stock.
Buy the stock and then sell covered calls against the stock.
Be exercised out of the stock.
Repeat the investing cycle.

He taught me to split my money into 3 categories; fixed income, stocks and cash. He explained that people do not keep enough cash on hand to be able to take advantage of opportunities as they presented themselves.

He showed me how chasing stocks, high fliers and penny stocks were pointless and showed how, by using options to earn income, I could get into stocks at a discount to their trading value, protect my portfolio and grow my capital consistently. He explained that while high flying stocks could produce spectacular gains, they can also crush a portfolio. He showed that through consistent annual gains while controlling any losses, my portfolio would grow and compound annually.

The Importance Of Being Realistic:

He taught me to be realistic in my expected returns, take small consistent gains, have patience, take advantage of market drops and to stop worrying about my investments. He discussed that it is important to think longer than a few months, but instead think years. He explained that there will always be calamities, unknown events and collapses in markets worldwide. He explained that by having cash always available I do not have to ever sell at large losses and by staying with large cap companies that will survive any economic change, I can consider averaging myself lower into those stocks that collapse in value.

The Decision To Use Options:

After paper trading for some time, I decided that my mentor was correct and that options were the best way to handle my investments. Through selling naked puts I could get into stocks at a discount and use other people’s capital to eventually be assigned shares. It was obvious that through selling covered calls I was being “forced” to sell my stocks and take my profits throughout the trading cycle. Stocks move up and down a lot. There are literally dozens of events that affect stocks but through my strategies I was able to profit no matter what direction stocks headed.

Over the next few years my money grew and every year I saw positive returns. The secret has always been to earn small monthly returns, have cash available to rescue any of my stock that has collapsed in value and take advantage of stock pull backs and market collapses.

Investing in stocks is incredibly risky. Companies change constantly and stocks move around a lot more than people realize. They can also stay depressed longer than many investors have the patience for. But options provide lots of opportunities for earning small gains despite the economic climate. While it is true that selling covered calls and selling puts does not provide a lot of protection, I developed additional strategies to try to protect my overall portfolio in market declines.

Since the SPY ETF was introduced in January 1993, it has become my preferred method of hedging market downturns.

My Capital Breakdown:

I now keep 30% of my capital in cash, 30% in bonds or fixed income and 40% in stocks. The 30% in cash might seem high but surprisingly, almost every year there are opportunities that present themselves and allow me to put my cash to use and earn very good returns. I then rebalance my portfolio and return it to 30% cash. This article discusses some of the bond portion of my portfolio.

Other Strategies:

As the years have passed I have spent time developing other strategies which I paper traded and found augmented my basic strategy of selling options. I developed strategies of rolling options, forward, up and down. I soon found that even in some of the most severe downturns I could delay assignment by timing the rolling of puts and using other strategies (which I have documented in my trades). I found that I could decide “when” I was ready to accept assignment from naked puts and after selling covered calls, how to delay being exercised out of my shares, even if the covered calls were deep in the money.

The Consistent 1% A Month:

The most important thing is consistency in return for the overall portfolio. I aim for a 1 percent return on my entire stock portfolio every month. So for example if I had a $20,000.00 portfolio, I would need to generate $200.00 in income. Often I found that the $200.00 is generated through using just a portion of my entire portfolio.

For example with Intel at $19.20 if I sold four naked puts at a $19.00 strike which brought in $.50 each, then I was committing $7600.00 to the Intel naked puts in the event I was assigned. However this left $12,400 in capital that was not invested. I would therefore sell further out of the money naked puts on other stocks for perhaps one half a percent return. As an example if Microsoft was at $25.00, perhaps I would sell 5 naked puts of the $23.00 strike for .15 cents.

This meant I would earn (in the example) – $200 (Intel) + $75 (Microsoft) for $275.00 or 1.3% and have a total of $19100.00 invested. I found that this happened quite often, providing many months where I was earning more than 1%.

With my capital spread out between two companies, with one at higher risk of assignment – Intel, and one at lower risk of assignment – Microsoft I am often earning better than 1% a month or 12% annually.

Basically the stock that was higher risk was bringing in the majority of the income and the other trade was bringing in less but kept a lot more capital in positions with lower risk of assignment.

Then with each month I would take the capital earned and compound it by adding it to the original amount. For example as per above, after the first month I had now earned $200.00 which meant I now had available $20,200.00 for investing. The next month I would have $20,400.00 and so on. Therefore there are many years where I see gains over 12% just through this compounding effect.

On top of this is the time when I may hold stocks for a month or two during which I may collect a dividend. That also adds up.

Taking Advantage Of  Fire Sales:

Finally there are those times when the market crashes and stocks have a fire sale. I have cash always available for such opportunities and I step in and pick up those deeply oversold stocks and wait for a bounce. Since starting investing in the mid 1970’s I have had at least 6 sell offs that saw returns greater than 60% as stocks recovered. So those returns are also added in. Suddenly I found I was on average, earning a lot more than 12% every year, but my trades remained conservative.

The Importance Of The Large Cap Stock:

By staying with large cap, dividend paying stocks that have options available I found that this style of trading has worked consistently for me. With stocks like Johnson and Johnson, Coca Cola, PepsiCo, Procter and Gamble, and McDonalds, I do not need to worry about them disappearing. Therefore when they collapse in value I can immediately pick up some shares to average lower or consider selling puts at what are many times large put premiums to average into the stock at a reduced price.

I can do this with confidence that one day the stock will recover. This is paramount to the success of my strategy. If I only earn 12% a year on a stock and it should go bankrupt or fall by 90% and not recover for decades, there really was no point in earning even 12% on the stock as the loss of capital will more than wipe out any gains made and damage my entire portfolio.

I also look to trade in large cap stocks that have volume in both the stock and options, which again makes it easier to implement my strategy. I look forward to an increase in option volatility and listen to the business news during the day to see if there have been any big swings in the market as this always means higher option premiums. As time progressed I learned to use moving averages and candlesticks to better time selling points.

Time Spent:

Now almost 4 decades later my overall strategy has become second nature to me.

To do my style of investing does not require a large time committment. I spend perhaps  an hour each day or evening reviewing my stocks and options.

I no longer chase rising stocks or buy into over valued stocks. Instead I just plod along aiming for that 1% plus a month.

Summary:

That then is the basis for my investing philosophy. I hope you will join me as I discuss my many strategies, methods of rescue, ways to protect capital that is risked in equities and stocks and markets in general. You can join or read about the benefits of a membership through this link.


 

Disclaimer: There are risks involved in all investment strategies and investors can and do lose capital. Trade at your own risk. Stocks, options and investing are risky and can result in considerable losses. None of the strategies, stocks or information discussed and presented are financial or trading advice or recommendations. Everything presented and discussed are the author’s own trade ideas and opinions which the author may or may not enter into. The author assumes no liability for topics, ideas, errors, omissions, content and external links and trades done or not done. The author may or may not enter the trades mentioned. Some positions in mentioned stocks may already be held or are being adjusted.