With all the hustle and bustle of market headlines in recent weeks, it can be easy to forget the fundamentals. Simply put, stocks are ownership stakes in a business. How that business is run matters. The price change shouldn’t meant too much on a day to day basis. Over time, the price will take care of itself. It’s the fundamentals that matter.
How the companies you own are being managed can be a big deal. That’s especially true in tumultuous market moves like today. A manager trying to react to short-term moves may succeed, but at a cost of giving up long-term competitive advantages.
But management also applies to how your portfolio is doing as an investor. If you’re loaded up with a variety of stocks and funds, you may have diversification. And while that’s great, it might not mean that you’re safe from more market volatility like what we saw in February. After all, just about everything declined in lockstep.
Being invested entirely in stocks, even if it’s with a diversified fund, simply means you’re likely to perform however the market does. That’s generally good, since most investors fail to beat the market—or even match it! They spend too much time chasing stocks that have already run higher or engage in trading strategies that don’t add to the bottom line in a meaningful way.
If you’re only investing with a market index in mind, getting the market return is great over time. Just bear in mind that a market correction can last 12-18 months. In the grand scheme of things, that isn’t so bad, but it can feel like an eternity while it’s going on.
And that doesn’t account for events like last month’s volatility, which sent the overall market index down nearly 10 percent in the space of a few trading days. That kind of move isn’t abnormal. It happens even in the best of bull markets. What’s been abnormal has been the trading action of the markets in the past few years. Volatility was too low for too long. Even with higher volatility, we can still get great returns going forward.
Nevertheless, without a portfolio management strategy, investors may be caught up in the crosswinds of higher market volatility. Even though market returns in the future are unknown, chances are they’ll be great—for those willing to stay invested and not cash out the instant there are storm clouds on the horizon. While investing means getting swept up in big trends, individual investors aren’t entirely powerless.
Investors in individual stocks can make some smart management decisions in this environment to protect their gains from this multi-year bull market. One strategy to employ is covered call writing.
It’s a conservative way of using the options market to get a better return out of a trade. For every 100 shares of a stock you own, you can sell a call option. Depending on the strike price and the option expiration date, it’s possible to use this strategy to get potentially double-digit returns out of an existing position.
It hasn’t been the best returning strategy in the past few years, but with the rise of more market volatility, it’s a simple, but effective money management tool that can be easily employed in your portfolio. Higher market volatility means higher options premiums to sell. And by setting a strike price and strike date on a stock you already own, you commit to a price where you’re comfortable taking profits in a position. It’s the closest you can come to having your cake and eating it too in the stock market.
For instance, in the past year, I’ve used this strategy with gold mining company Yamana Gold (AUY). I’ve bought shares under $3, and sold the $3 calls on the stock. Over time, I’ve added to my total share stake anytime they’ve been under $3, and sold calls when the price has been over $3. With shares trading between $2.50 and $3.50 in the past year, it’s been a solid way to make a decent return in the still-sleepy gold mining space.
In pure dollar terms, I’ve been able to get nearly $0.60 per share each year in options premium at the $3 price. While that doesn’t sound like much, it’s a 20 percent return on a $3 share price—and I’m buying shares below that, guaranteeing a small capital gain as well. Some of my shares have been called away, some haven’t and I’ve been free to go back and sell covered calls again. If shares start to trend higher, I can look to the $4 calls, or higher.
To some extent, how I profit off this trade in the future will depend on how the market is treating shares. Right now, I can get a great annual return using a somewhat aggressive call option strategy. Different stocks may employ different ways to use covered call options.
For a more dividend-oriented company like McDonald’s (MCD), for instance, I may sell call options against my holding that have a far higher strike price. The percentage return may only add 5 percent instead of 20 like with Yamana, but my risk of being called away is substantially lower—and McDonald’s pays a sizeable dividend along the way.
The trade-off, of course, is that you might get called away on a position that ends up running far higher. Covered call writing may not feel like the best strategy in a market meltdown, where you end up keeping shares of a stock that then gives up most of its gains. But as long as your rationale for owning shares of the company haven’t changed—just the market price—you should see shares recover in time.
How you manage your portfolio matters. With a covered call strategy, you can increase your portfolio returns without substantially increasing your risk. And with market volatility on the rise, it’s the best time in years to start using this simple tool to get the most out of your portfolio.
Andrew Packer is a Senior Financial Editor with Newsmax Media. He currently writes the Insider Hotline investment advisory, serves as investment director for the Financial Braintrust, and writes the monthly newsletter Crisis Point Investor.
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