Last week I wrote to you about how to wait for the fat-pitch setup in your favorite investments – like gold. This week I’m going to show you how you can make some money while you wait and share with you a secret about why this technique can be so powerful.
To briefly recount, we looked last week at how the Re-Entry Rule is conservative by nature. It takes a pretty strong rally to trigger a Re-Entry Rule. We want that because we want to avoid the many head-fake rallies that tempt investors only to disappoint … and devastate.
At the time that the Re-Entry Rule triggered, the top of the Low Risk Zone was just below $110. Here’s an updated chart on gold:
[TradeStops Tip: You can add a Low Risk Zone alert to your TradeStops account by adding a position on the symbol GLD to a manual watch-only portfolio and then putting a Low Risk Zone alert on that position. You can watch a recently recorded webinar on using TradeStops to research stocks by clicking here.]
But today I want to share with you a way to make even more money off of these situations. Let me illustrate this idea with our current example of GLD.
GLD triggered a Re-Entry Rule right around March 2, 2016. At the time of the Re-Entry Rule trigger, the top of the Low Risk Zone was near $110.
On March 3, 2016 you could have sold April 2016 puts with a strike price of $110 for $0.45. What exactly does that mean?
It means that if you sold 1 April 2016 $110 put on GLD for $0.45 then you would be on the hook to buy 100 shares of GLD for $110 each. That would be an $11,000 investment in GLD should you get put the stock. You would get $45 per put (100 shares x $0.45 per share) for taking this risk.
Should you get put the stock, your cost basis per share would be $109.55. That’s your $110 strike price minus the $0.45 per share you were paid when you sold the put.
If you wanted to try this strategy at current market prices and Low Risk Zone levels you could sell the April 2016 $112 puts for $0.55. That would be $55 of income for each put sold and a cost basis per share (should you get put the shares) of $111.45 (strike price of $112 minus $0.55 premium per share).
It’s important to note that a big part of this strategy is that you can only sell as many puts as you are willing to be put the stock. Using our most recent example, you need to be willing and able to buy $11,200 of GLD (100 shares at $112 each) for every April 22, 2016 $112 put you sell.
What are the benefits of following this strategy versus just waiting for GLD to pull back to the Low Risk zone and buying it there? There are several benefits.
First of all, you’re generating some income … and you get to keep that income whether or not GLD ever pulls back to the Low Risk Zone. I know that $50 may not seem like a huge windfall but hey, fifty bucks is fifty bucks, right? If you do that 10 times with 10 of your favorite investments you are waiting to get into, that’s $500.
To me, though, there are even more important benefits to this strategy, albeit more subtle ones. There are psychological benefits.
You are setting your own terms. You are telling the market to come to you. You are getting paid to wait, whether the market comes to you or not.
Moreover, you are calming your nervous inner investor that is likely shouting at you that you’ve got to get on board this gold rally before the train really leaves the station without you. You’re taking an action. It’s a small action but it’s a definite action nonetheless.
Such subtle psychological benefits are of incalculable value. They produce a sense of confidence … and mastery. You’re stepping up to the plate and giving yourself very high odds of getting on base as well as keeping the door open to hitting a fat pitch out of the park.
While these small confidence boosting strategies may not add big short-term gains to your portfolio, their cumulative impact on your long-term gains will blow you away. You will be in command … and your portfolio will benefit.
To patience, mastery and profits,
Richard M. Smith, PhD