September 2, 2015
Earn Income By Selling Market 'Insurance' To Investors
By Amber Hestla
The bull market lasted more than five years. Then stocks traded sideways near
their all-time highs for a few months. Suddenly, the S&P 500 fell around 20%
within a few weeks...
You might think I'm describing the recent market action, but I am actually
talking about 1962.
What happened then is eerily similar to what's going on now...
The initial decline in stock prices came in the spring of 1962 (1 in the chart
historians blamed President Kennedy and his interference with capital markets.
At the time steel companies and the steelworkers' union were in
negotiations... but the two sides were unable to compromise, and a strike
With a possible work stoppage in the cards, steel companies increased
production and manufacturers stockpiled steel. This would allow the steel
companies to continue operating through a strike. They also decided to raise
prices so they would have a cash cushion.
Kennedy didn't like this and instructed government officials to visit company
executives at their homes to express his displeasure while he made a speech
about corporate greed. Steel companies rolled back the price hikes, but
traders became nervous about the unprecedented level of government
intervention during peacetime and stocks sold off.
As the chart below shows, there was a quick bounce, but it was followed within
a month by another low (2 on the chart). But the final bear-market low came in October (3) and was driven by another news story: the Cuban Missile Crisis.
Once it became clear in October that peace would prevail, a new bull market
began and the S&P 500 gained more than 80% over the next 40 months.
I believe we are likely to see a repeat of the 1962 stock market pattern. It
won't be exactly the same, of course, but I am looking for a lower low in the
major market indices. The recovery we have seen in the past few days could be
driven by investors buying the dip and hoping for a continued bull run, or by
traders covering short positions.
This time could be different but, in my opinion, we are unlikely to see a real
recovery in stock prices for at least a few months. Either way, my investing
strategy won't change -- even in a bear market. There will always be
undervalued income opportunities if you look in the right places.
How I Plan To Profit From Fear In The Market
thoroughly enjoy times like these because that's when readers of my premium
advisory, Income Trader, and I pocket bigger income checks...
When traders become spooked and bearish headlines dominate the news, this
translates into a surge in the volatility index (VIX).
The VIX measures the implied volatility of S&P 500 index options. When
investors become scared, it typically goes up, which means that investors are
willing to pay more to hedge their downside risk, or protect any gains.
I'm willing to take their money to buy their stock... but on my terms.
I set the price I'm willing to pay for their stock and in return
they pay me
cash up front. I do this by selling put options.
Think of it like this. Imagine if home and auto insurance premiums fluctuated
with the weather. If the weather is good, then insurance is cheap. But if
there's a hurricane looming, then premiums skyrocket.
Now you could take the chance that a hurricane won't hit and not pay the
sky-high premiums. Or you could hedge your bets and pay higher premiums to
protect your personal belongings.
To extend the metaphor, the VIX is the market's way of measuring investor fear
of potential devastation. Just as when headlines indicate it will be a bad
hurricane season and insurance premiums jump and consumers are willing to dish
out more to protect their valuables, so too does the VIX indicate whether
investors are willing to pay more to protect their investments.
When I sell puts, I'm acting as the insurance company... but I'm very
selective with which stocks I will "insure." I won't pick stocks that are
likely to be swept up in a hurricane. Instead I focus on the companies least
likely to be affected. Just like the best insurance companies are masters of
pricing in risk -- the good ones always make sure they come out on top -- I
simply pocket the premium and move on.
Just like a good insurance company, you have to have good underwriting skills
to know which stocks to "insure." And so far my "underwriting" skills have
been perfect. Every stock I've sold a put option on I've closed out as a
winning trade. In other words, I've made money on every trade.
For example, I recently told my readers about a company that's deeply
undervalued, generates $42 billion in revenue and has a forward
price-to-earnings ratio of only 4.8... a company that I'm willing to "insure."
In return my readers and I will instantly pocket anywhere from $60 to $600
with a click of a button in our brokerage accounts.
You can still reap the cash rewards from this stock today, along with many
other companies my readers and I are "insuring." You only need to follow my
simple underwriting tips -- which I've detailed in
this quick 8-Minute Tutorial on selling put options.
To learn more, simply visit this link.
Options & Income Strategist