Monday, June 8, 2009

Double-Digit Bear Market Income

The Double-Digit Bear Market Income process involved buying depressed shares of the safest blue-chip companies in the world... companies like Microsoft, Procter & Gamble, Coca-Cola, and Verizon. The bear market drove shares of these companies down to mouth-watering valuations... and we bought when no one else would.

Most of these companies pay dividends in the 3% to 6% range... and most importantly, they raise their dividends year after year, which is great for compounding your wealth. Now, here's the other half of the process...

Last October, the VIX reached an all-time high of 89. The VIX is known as Wall Street's "fear gauge." It's an index that measures the price investors are willing to pay for protective options... the price of "portfolio insurance." People were paying extraordinary prices for options back then. This made it lucrative to sell "covered call options."

A covered call strategy is when you sell the potential future upside in a stock to another investor in return for a large fee, paid in cash, immediately. This fee is an "option premium." By collecting this option premium, it's easy to double or triple the income you receive from your stock positions. Your downside hasn't changed, except now you have the option premiums to pad your returns.

If you believe a stock is going to shoot the moon, you don't want to sell away your upside. But in a bear market, selling away upside on giant, stable companies for 12% upfront cash payments makes perfect sense. The cash payments give you both safety and income.

Take Coca-Cola as an example. We bought the stock for $42.27 in November, during the heart of the stock market crisis. Then we sold a May $47.50 call option against our stock. If Coke stock rallied past $47.50 in six months, we were required to sell it at $47.50. We earned $3.70 upfront in cash for selling this option...

Between November and May, we also received $0.82 in dividends from Coca-Cola. In other words, we made 11% cash income from our Coca-Cola investment in six months. Then the stock market bounced, and Coca-Cola's stock rose, too. We sold for $47.50 and made 18% on the stock price... for a total 30% return on investment.

We used the exact same technique to make...

· 15% from Altria (12% was cash income)
· 21% from McDonald's (13% was cash income)
· 28% from Microsoft (12% was cash income)
In the past few months, however, the stock market has calmed down. Since March, the VIX has declined from 50 to 30. We no longer have the "slam dunk" conditions we had... where traders were willing to pay us huge premiums.

I'm currently recommending holding off on opening new covered call positions. It's much more difficult to find great opportunities .

You should keep a close eye on the VIX. There's still plenty of danger out there... gigantic government debts... falling commercial real estate prices... rising interest rates. The VIX could easily return to the 35 or 40 area. If the VIX reaches these levels, the Double-Digit Bear Market Secret strategy is back on.

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