That's the position a lot of people are finding themselves at the moment and some part of that is, of course, from the overall market drop but a lot of that is from paying too much when they bought the stock in the first place. At Philstockworld.com, we teach our Members to NEVER pay retail prices for a stock – that's what retail traders do – not professional traders!
First of all, see our article about Scaling Into Positions from the Strategy Section of Philstockworld.com. The very short story is that you should never make a full commitment to a position early on. You should break your portfolio down into Allocation Blocks (see Strategy Section) equal to no more than 10% and preferably 5% of your portfolio so that no one position can break you and THEN you break your allocation blocks into quarters and each position should be started with a 1/4 entry.
Now, not only can no single position damage your portfolio but no single entry should be able to damage it either. For example, Disney (DIS) seemed like a very safe stock and, even at $140, it wasn't terribly overpriced but then the virus hit and all the movie theaters closed and the theme parks closed and POOF! – half their business disappeared and the stock dropped to $85 before recovering a bit to $94. Had you bought DIS for $140 in February, you'd be down 33%.
Had you, however, made a 1/4 allocation to DIS in Feb, let's say buying 100 shares for $14,000 in a $50,000 allocation block, you would have plenty of buying power to buy 100 more at $90 ($9,000) and your average on 200 shares would be would be $115 ($23,000) – not even 1/2 of your $50,000 and down only 18.3% on the larger position.
If DIS dropped another 33% to $62 (and we're assuming you still want to be in the stock, of course), you would have $27,000 on the sidelines in your allocation block and you could buy 200 more shares for just $12,400, bringing your average cost down to $88.50 and you STILL have $14,600 on the sidelines. More importantly, you would have 400 shares of DIS at $88.50 ($35,400) that would have cost you $56,000 if you had bought them all at $140 so you'd saved $20,600 by scaling in patiently.
Do you miss out on upside if DIS goes to $190 instead of $90? Of course you do but then you have a nice, cheap entry on DIS and you take the rest of your money and find ANOTHER stock that's a good deal – THAT's your downside! The upside is having plenty of capital to spend during a crisis and a portfolio that's full of either winners or positions you can well afford to fix – how does that sound?
Now, what if we combine that with a fool-proof method that guarantees you'll never buy a stock again for the listed price. In fact, right now, I will tell you that the MOST I would pay for DIS is $80, not $94 AND that I will either own DIS for $80 or I will make up to $15 (19% of $80) for NOT owning it this year! Sound interesting? Read on…
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Our watch levels for our next set of bullish market plays have been Dow 21,600, S&P 2,600, Nasdaq 7,750, NYSE 10,500 and Russell 1,100 and this morning the Futures are up 3% so we'll see if it holds through tomorrow and, hopefully, they now form a floor we will be able to watch so we'll know when to be worried that the rally is running out of steam. There's no point in having watch levels if we don't act on them and the plan was to work our way into new bullish positions is with our famous Buy/Write Strategy – simply the best way to initiate new stock positions for the average investor. See:
Given that it is now less likely that the market drops more than 10% from here, picking up stocks for 20% below their current price is a sensible way to begin building some new positions. By picking value names and concentrating on plays that give us much better prices than the ones paid by the average retail investor using very basic option strategies we can stay ahead of the game and buy with some comfort. This strategy, which we call a "buy/write", as we buy the stock and write options against it, is one of our most effective tools for dealing with a uncertain markets.
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Not only does the Buy/Write Strategy give you an initial discount on your ownership of a stock, but you can use variations on this strategy to give yourself another 10-20% three to four times a year! If you have a retirement account that allows you to write covered calls and sell puts in it (check with your broker, of course, some do, some don't) why wouldn't you want to generate an additional discount off the stocks you plan to hold long-term? If you plan on accumulating a stock over time, why on earth would you even consider paying "retail" when we can teach you a simple method that can put money in your pocket?
We no longer have the absolute bargains we used to have but there are still plenty of stocks that are trading at 50% off their highs and, if this rally is going to continue, that spells huge opportunity for us. It is always important to select stocks that have strong underlying fundamentals which we intend to hold long-term.
As long as you are willing to own 100 shares of a stock – this system can reliably give you a 10-20% discount off the current market price. It's simple, easy to follow and is ideal for trading in a volatile market.
Let's say, for our first example, we want to buy DIS at $94 but, as I mentioned above, I'm not a sucker who pays retail prices and I'd rather buy it at $80. I don't HAVE to buy the stock. I can sell a put contract which is, very simply, a contract that allows the owner of DIS shares to PUT them to me (force me to buy them) for the contract price at any time during the length of the contract.
Why will a holder of DIS stock PAY me to agree to buy his stock? Most likely, he is paying for insurance that limits his losses. For instance, the DIS Jan 2021 $97.50 puts are $17.50. That means the person who owns DIS at $94 today, is willing to pay me $17.50 to promise to buy DIS from him for $97.50 between now and January. He is guaranteeing a net sale of $80 ($97.50 less the $17.50 he paid me) and, of course, he thinks DIS will go up more than $17.50 – he's just not SURE that will happen and wants insurance.
From our point of view, however, we are getting $17.50 in our pockets now and all we're doing is signing a contract that says the seller can make us buy 100 shares of DIS (per contract) for $97.50 between now and the Jan 15th, 2021 expiration date. If we are assigned (and even if not), we keep the $17.50 x 100 contracts = $1,750 so there are 2 possible outcomes: Either DIS is below $97.50 and we end up getting 100 shares for net $80 ($8,000) or it's above $97.50 and we just keep the $1,750, which is 21.9% of 80 8 months from now.
That is how we either buy our stocks for a discount or we make 15-20% a year for doing nothing. Not a bad way to start investing, right? If you had bought all of your stocks for a 15-20% discount, would your portfolio be better or worse off than it is now?
If a stock pays a dividend (and few do these days) and you'd rather own the stock to collect it, you can do something more complicated we call a "Buy/Write", which is buying the stock and writing both puts and calls against it. This is adding a new layer to the above strategy but it can be very powerful.
Tanger Factory Outlets (SKT) is my favorite under-priced REITs and, at $1.43, their dividend is 33% of their $4.26 price. Very likely they will cut it but, if they don't – you sure do want to own this stock! So, rather than just sell the puts, we can buy the stock and sell the puts and calls. The calls, if we sell them, allow someone to force us to SELL them the stock at a certain price over the term of the contract. Our set-up would be:
- Buy 1,000 shares of SKT at $4.26 ($4,260)
- Sell 10 SKT 2022 $5 calls for $1.50 ($1,500)
- Sell 10 SKT 2022 $5 puts for $3 ($3,000)
As crazy as it seems, we are buying 1,000 shares of SKT for a net CREDIT of $240 and we are obligating ourselves to buy 1,000 more (the puts) at $5 ($5,000), which would put us into 2,000 shares at net $4,760 or $2.38 per share. That is our worst case to the downside, owning 2,000 shares of SKT 44% below the current price so, if we have $20,000 allocation blocks, this is a very easy place to start.
If SKT is under $3, we are likely to get assigned and own it at $2.38 but then we can sell more puts and more calls to lower our net further (not to mention collecting the 0.35 quarterly dividends!). If the stock is over $5, we will get "called away" by the person we sold calls to at $5 or $5,000 and our profit would be $5,240 in two years.
Either own the stock at a tremendous discount or make a massive profit at just 20% above the current price – are you seeing the merits to this strategy?
This is a simple example over a short period. The key is to pick stocks that are:
- Trading near lows and are undervalued
- Fairly volatile
- NOT likely to go bankrupt
- Either pay dividends or have good growth
- Have a clear path of continuing contracts to write
- You don't mind owning long-term
In short, if you think SKT is a relatively good deal at $4.26 – why not commit to buying it for $2.38 instead? Also, to take a more advanced view, the trade doesn't end on Jan 21st, 2022. You have a $2.38 basis in Tanger, who may one day begin paying dividends again – even if they have to halt them for a while. If they do, that's another 60% annual return on your money at $1.42. Additionally, you can continue to sell calls against the stock. Let's say SKT falls all the way to $2 (down 50%) and you are stuck in it at $2.38. You can still sell 2024 $2 calls for about $1 and drop your basis to $1.38 – maybe lower!
With a $1 lower basis of $1.38 after selling another call, we don't mind being called away at $2 (up 52%) and, if we sell $1 puts for 0.50, that could drop the net to 0.88 or 0.94 if assigned so then 4,000 shares at 0.94 is $3,760, which is our risk of ownership if it plays out like that (SKT has to not go bankrupt, of course).
Another application of this strategy is to hedge against riskier trades like hospitals. We like Tenet Health Care (THC) but the virus is making things crazy though we feel that the Government will guarantee the hospitals payments, removing a lot of the financial risk. Buying that stock for $11.89 and selling the Jan, 2022 $10 calls for $5.50 and the 2022 $10 puts for $3.40 nets us into that stock for just $2.99 out of pocket. That's a 75% discount on the stock and, if we are called away at $10 on Jan 21st, 2022, it will be with a $7.01 (234%) profit. If things go poorly and THC drops like a rock and is below $10 on Jan 21st, 2022, we would be obligated to buy another round at $10, which would give us an average entry of $6.50, which is 45% LESS than it's trading for today. That's your WORST CASE!
How often does someone come to you with a way to buy a stock at a 45% discount that can pay you a 234% profit if it simply DOESN'T FALL 10% for 20 months?
We identify dozens of trades like this every single week over at Philstockworld. While you can do this with almost any stock, we are able to identify unique option opportunities that make certain stocks a little more favorable than others and we can teach you to do it too.
At this point you may be saying to yourself: "If I can learn to buy all my stocks for 27.8% discounts, I bet I can improve my trading performance." That's exactly what hedge funds do and there's no reason you can't learn to do it as well! The great thing is – there is always an option.
We have featured over 100 of these plays in past months in member chat and our Buy Lists (see articles above) and, in this scary and volatile market, they are one of the best ways for you to capitalize on the volatility while hedging the risk on your upside plays and positioning yourself for a (we hope!) a long-term recovery. If the market does end up flatlining however, we are positioning ourselves in stocks at good prices that can generate a very reasonable monthly income – which will keep us flexible in a challenging market!
Again, if you sign up for our newsletter service, The PSW Report, using this link, we will be featuring some of these trades weekly and if you want live Alerts of Trade Ideas as we identify them or you want to view our daily trading chat live, then check out a Basic or Premium Membership – It's a good time to stop watching other people make money and get into the game.
