Comment by phil

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phil
April 17th, 2014 at 2:30 pm

FYI – We're doing a special Educational Seminar next week re. "7 Steps to Making 40% Annual Returns," which is a very good article for all to read.  Here's my notes and two trade ideas we'll be using:

Well, step one is wait for a sell-off.  I guess we’ll use a couple of low stocks as an example.

Step 1: Wait for a sell-off.





 

Step 2:  Check the Fundamentals

Let’s just summarize and say that we like HOV and FCX as long-term plays.  They are not classic value stocks, but we find them interesting.

Step 3:  Check the Technicals

More so than step 2, we feel that both of these stocks have a supportable floor underneath them and that the market conditions are right for a recovery.

Step 4:  Note earnings. 

HOV does not report until early June.  March 5th earnings were a big disappointment with a 0.17 loss that came against very strong comps from Q4 of 2012 and, of course the weather was a factor. 

FCX is suffering from low copper and gold prices but still managed to make $700M in Q4.  Cost-cutting efforts are leading to upbeat profit expectations and metal prices coming back will be a bonus.

Step 5:  Track Implied Volatility

Both of these stocks have nice, high volatility, which is perfect for us to sell options into. 

Step 6:  Sell 2-3 month short call options at the money.

We can buy HOV for $4.49 and we can buy FCX for $33.21.   Since HOV does not pay a dividend, and there is no major benefit to owning the stock, we will do an example of an “artificial buy/write” with HOV and a regular buy/write with FCX. 

For FCX, we buy 500 shares of the stock for $33.21 ($16,605) and we sell 5 2016 $28 puts for $3.05 ($1,525) for net $15,080.   This obligates us to buy another 500 shares of FCX at net $28 ($14,000) and would give us an average entry on 1,000  shares at $29.08, which is 12% below the current price.  Using this base, we sell 5 June $33 calls for $1.45 ($725), which now drops out net cash outlay to $14,355.

If all goes well, FCX is over $33 in June and we get called away from our initial $15,080 position for $16,500 and we get to keep the $725 from the calls we sold.  That’s $17,225 back from $14,355 or a $2,870 in profit (20%) in just 60 trading days!  Well on the way to over 40% annualized returns. 

With HOV, rather than buy the stock, we can buy 10 of the 2016 $3.50/7 bull call spread for $1.10 ($1,100) and sell 20 of the $4.50 puts for $1.05 ($1,050).  That gives us a 0.05 basis (net $50) on our long position, which is $1 ($1,000) in the money to start.  We are obligated to buy 1,000 shares of HOV at net $4.55 ($4,550) if it finishes under $4.50 (the current price) in 2014.

For income, we can sell the Aug $5 calls for .25.  Selling just 5 of them (1/2 cover) for $125 is already a 150% return on our $50 outlay in 4 months plus, if HOV stays on track, we have another $1,000 coming so there’s no reason to be greedy, is there?  Leaving the position half-covered gives us plenty of room to roll if the position goes up faster than we thought and the flexibility to sell lower-strike calls if HOV can’t stay over $4.50 (the Aug $4 calls can be sold for .75, which puts another $375 in our pocket if we get worried). 

Step 7:  Wash, Rinse and Repeat

Making trades like this each quarter can lead to a very impressive steady income.  When the stock trades lower, you simply keep selling and, when the stock trades higher, you either roll the calls you sold (and benefit from the appreciation) or you let yourself get called away and move on to the next bargain.