Bill Bonner (The Daily Reckoning, UK):

We are high over the African veld… at least, we think it is called veld. That’s ‘field’ to you and us. And we’re so high above it we can’t see it anyway.

After a few days in Johannesburg, we’re on our way to Dakar. Why would Bill want to go to Dakar? We asked the same question. But Dakar is just a stopover on the way to Washington.

Meanwhile, there are things to be reckoned with.

When we left the ground, it appeared that we were finally getting the shakeout in gold that we’ve expected… and maybe the beginnings of a shakeout in stocks too.

(Whoa… we just landed in Dakar… got an internet signal. Seems gold is down another $22. The Dow, however, rose 51 points yesterday.)

On Friday, the London gold market saw the highest volume traded in history.

London gold expert, Dominic Frisby, sent this commentary:

“After peaking last Wednesday at about $1,220 an ounce, the price has fallen almost $100 in just four trading days. Friday’s capitulation – some $60 – was particularly ugly. It shows just how much speculative, hot money there is in the sector.

“So what now?

“In the week to last Wednesday 7 December, almost $300m of call options (options betting the market will rise) were traded in the largest gold exchange-traded fund (ETF), GLD.

“That is more than the entire call volume of the second and third quarters of this year – in just five trading days. On Wednesday alone, trading volume in GLD calls amounted to almost 50% of what the market traded in the entire second quarter.

“That is a sign of extreme speculative excess. It is not the time for short-term investors to buy. At such extremes, you have to ask: where are the next buyers going to come from?

“As we head into year end, there are a lot of fund managers who will want to lock in their profits for the year.

“I’m afraid that means they will sell their gold – and anything else they own that has done well – at the slightest hint of a turn in the markets, because they will want to secure their gains (and their bonuses) on what will have been an excellent year. That’s what we saw on Friday and why the market fell so hard, so fast.

“In the short term, this does not bode well for any market – except one. “It may be that we are finally seeing the end of the ‘Great Reflation Trade’, this astonishing rally out of the crash.”

Click here for the rest of Mr. Bonner’s article at The Daily Reckoning, UK Edition.

Many investors will try to profit from or hedge against the expected pullback by purchasing put options on the broad market proxies, such as the Spyders (the ETF which tracks the S&P 500). This type of trade makes you money when the market falls. But you are likely getting worse leverage than you could have a short while ago, making it more difficult to profit on your position.

Of course, we’ve been here before. Or as Yogi Berra liked to say, “It’s like déjà vu all over again.”

Recall, back in November of 2008 the markets began an impressive run-up, hitting the 20% milestone, too. Then all hell broke loose.

As a result, not every market observer, myself included, is completely convinced by the recent move. But I will say this – seven notable differences exist between then and now, leading me to believe this very well could be the start of a new bull market.

• There’s hope for housing.

On Tuesday CNBC did a feature story on home sales in foreclosure central – California. In one suburb outside Stockton, where one out of every 67 homeowners received a foreclosure notice last month, new home inventories miraculously plummeted from 130 to just 17. One builder went from four sales in five months to nine sales in one month. Tax incentives definitely played a rule. Nevertheless, the trend jives with the latest overall market data.

Recall, new homes sales jumped an unexpected 4.7% in February. It also lends credence to newsletter guru Dennis Gartman’s latest prognostication that “we’re going to have a shortage of housing in the not too distant future.”

Another positive – lumber prices, a leading indicator for the housing market, rebounded roughly 30% in the last three weeks. (The housing market accounts for two thirds of lumber consumption.) Add it all up, and this data is hardly overwhelming. But it’s certainly less bad (see # 3 below to understand why).

• Takeover rumors are moving stocks again.

In a clear sign of optimism and normalcy, takeover rumors are once again returning to the market. And, more importantly, they’re moving stocks and spurning heavy call options buying. For proof, look at the recent moves in Black & Decker (NYSE: BDK), Textron (NYSE: TXT), Allergan (NYSE: AGN) and Illumina (Nasdaq: ILMN), to name a few.

• From bad to less bad.

Home sales. Durable goods orders. The ISM Manufacturing Index. These are just a handful of the economic data points that have gone from bad to less bad in recent weeks. At the same time, financial companies are beginning to wean themselves off of their government handout dependency.

Five banks announced they returned money given to them under the TARP program. And the TED Spread – a key indicator of perceived credit risk in the economy – is back below 100 basis points (bps) after peaking last October at 464 bps. (Keep in mind, the historical average TED spread is 30 basis points, so there’s still a ways to go.)

• No halitosis.

The November rally that faltered was led by defensive stocks and lacked breadth. In other words, a large portion of the market did not come along for the ride. However, this go-round we’re witnessing widespread strength, particularly in financials, commodity related companies and semiconductors, suggesting the move is sustainable.

• Volatility is dropping.

Right about the time we accepted one-hour 400 point swings as normal, their prevalence dropped off considerably. Look no further than the CBOE Volatility Index (VIX). After peaking at 89.53 last October, it’s back down to more reasonable level around 40. More simply put, the expected market vulatility has been cut in half.

• The market’s always out front.

Countless studies prove the market is the best leading indicator, rallying three to seven months before the economy bottoms. That doesn’t mean we’re immune to head fakes. The classic example comes from the last “severe” recession from 1973 to 1975, when stocks rallied in early 1974, only to stumble again.

But talk about history repeating itself. We experienced the same false rally late last year.

Just like in 1975, when the Dow rallied 36.2% in the three months before the recession finally ended, the recent market move could be the real deal, too.

• Bears out proselytizing bullishness.

In a clear sign of a market bottom, the most bearish investors in recent times found, well, bullishness. This includes Jeremy Grantham, who hated stocks for the past decade; Bill Fleckenstein, who shut down his 13-year-uld bearish fund to go long stocks; Steve Leuthuld, whose Grizzly Short Fund rose 74% in 2008; and Whitney Tilson, another one of the most bearish fund managers in recent years.

Don’t be quick to discard their change of heart and bullish comments as mere bloviations. These guys are the real deal, having predicted the downturn well in advance… and profited from it handsomely.

If this bull market is legit, I’ve already tuld you which small cap companies will perform best here and here.

Turns out they’re already leading the charge, outpacing large caps by a full six percentage points since the March 9 lows, based on the Russell indices.

If you haven’t positioned your portfulio accordingly, take heed. This could be your last chance.

Source: Wall Street’s New Bull Market: 7 Signs the Bear is Dead…

But what is bad for the economy and terrible for the market does not have to wreak havoc on your portfolio. By employing the right strategies, you can multiply your wealth safely in just about ANY market. In fact, there are a number of investment strategies that have never been as safe and profitable as they are today.

Here are several strategies you should strongly consider right now:

• Selling Covered Calls

Selling (also called “writing”) covered calls is one of the safest ways to generate extra income from your portfolio, especially in today’s market. Due to the fear and volatility in the market, option premiums are much higher than their historical averages. As a “seller” of options, that works in your favor. This is a strategy that could easily and safely generate 20% annual income.

Selling covered calls is probably the lowest-risk form of options trading. In fact it is less risky than simply buying stocks. The strategy involves buying a stock and then selling someone else the right to buy it from you in the future. For this privilege, the option buyer pays you cash up front, thus lowering your cost basis for the shares you purchase.

Here’s a hypothetical example of how it works…

Let’s assume stock ABC is trading for $10 and the July call options on this stock, with a strike price of $11 are selling for $1.00. To initiate a covered call, let’s assume you purchase 100 shares of ABC. Then you sell one call option on ABC, representing 100 shares. You would immediately receive $100 in your account, therefore your cost basis on this transaction is $900 ($1,000 – $100).

There are three possible outcomes to this trade:

• If ABC is trading for any amount over $11 at the option expiration date, the buyer would exercise his right to purchase the stock from you for $11. In this case, you would make 22%, based on your cost basis of $9.

• If ABC is trading for less than $11 but greater than $9 at expiration, you would still own the shares at a gain, and you would pocket the cash you received up front. You could then start the process all over, to generate another round of income.

• If ABC is trading for less than $9 at options expiration, you would be holding the shares at a loss. But the income you received up front would offset the loss. And you could repeat the process again to recoup some of the loss and generate additional income.

The key to this strategy is to write covered calls on stocks that you would like to hold for the long term. These could be stocks you already own or new positions. The stocks you select should be those that you believe to be very safe and cheap. And you should employ this strategy at a time when option premiums are large – as they are now. Ideally, you will be selling options that expire within three to five months.

When the strategy works out in your favor (and it will if you employ the rules above), you can generate better than 20% annualized income on a conservative portfolio of stocks. On the occasions when the stocks fall below your cost basis, you would own a stock that you wanted to own anyway… but at a much lower cost than if you had just purchased the shares.

By writing covered calls on high quality dividend-paying stocks you can get an extra bonus. Best case scenario, you will keep the option premiums, you’ll keep the dividends, and you’ll keep the stock too!

• Selling Puts

Selling puts is another strategy that can generate an annualized yield in the neighborhood of 30% – 50%. When executed properly, a put selling strategy can be highly profitable and carry very low risk. This is especially the case in a market like we have today, where fear is high and option prices are elevated.

You can also sell puts with the goal of generating income. In this case, you want the put to expire worthless so you can capture the option premium. To accomplish this goal, you sell puts that are out of the money on stocks you believe to have very little downside risk… and which you would be willing to purchase at a much lower price, if necessary.

Here is an example…

Let’s assume that stock XYZ is selling for $13. We’ll also assume the stock has already fallen a significant amount (not too hard to find in today’s market) and you believe the rock bottom liquidation value of the company is $8.

With the stock trading at $13, the July $10 put option is well out of the money and selling for $1.50. You decide to sell these puts. When the trade closes, $150 will automatically show up in your account for every contract you sold.

The only way you could lose money on this trade is if XYZ trades below $8.50 ($10 – $1.50) on or before the option expiration date in July. That is a 35% drop from the depressed level the shares of XYZ are trading today.

And in the unlikely event that you were obligated to purchase those shares, you should still come out okay. After all, the liquidation value of the company is $8 a share and your cost for those shares is just $8.50. So the downside risk should be very small.

Remember, this strategy should be employed on stocks where you believe the downside risk to be minimal. And you should only employ this strategy on stocks that you would be GLAD to own at a price below where you sell the put.

You should also have a reasonable understanding of the true valuation of the company. For this reason, I would exclude most financial and insurance companies from this category, as very few people (including the insiders) have any idea how much these companies are worth or what is on the books.

In today’s market, you can expect a well executed put selling strategy to generate an annualized yield of 30% to 50% with limited risk. Selling puts in this environment and following the rules above can put big odds in your favor.

By selling put options, you could buy super-high quality stocks as much as 50% cheaper than today’s historically low prices. PLUS you’ll get cold, hard cash deposited in your account instantly… adding to your annual income!

Where You Can Learn These Strategies… and a Lot More!

By no means are these the only strategies that can be highly profitable in today’s market. We are also seeing a once-in-a-generation opportunity in high quality corporate bonds. Invest in the right bonds and you can see significant capital gains plus income… without taking stock market risk.

This is also an excellent market for shorting stocks. But you should not go out and just short any stock. The inevitable bear market rallies could put you in the poorhouse. The lowest risk opportunity is to short those stocks that are almost certainly going to zero – companies with an impaired business model and a massive debt load. There are dozens, if not hundreds of these companies out there.

Now for some even better news: you don’t have to do all of this on your own…

In June, at the Turnberry Isle Resort & Club in Miami, Investor’s Daily Edge and Mt. Vernon Research have asked nine top investment experts to share their number one strategy and top recommendations that are making a fortune in today’s market. Of course, all of the above topics will be covered.

To learn more about this conference and the once-in-a-lifetime opportunities we’ll be discussing, click here.

Source: Two Strategies Perfect for Today’s Market

Let me begin by saying that options are tools, nothing more. Tools can be used to build something. Or they can be used to tear something down.

The key is to understand and master your tools and, more importantly, not destroy wealth when your intention is to create it.

Let’s start by defining our terms…

The Difference Between Put & Call Options?

Here are the differences between put and call options:

• A put option gives the owner the option of selling a stock at a specific price, again known as the strike price, over a given period of time.
• A call option gives its owner the option to buy a stock at a specific price, known as the strike price, over a given period of time.

The key advantage of buying options is that it allows you to control a large amount of stock for less money than it would cost you to buy the underlying shares.

• If the stock moves up rapidly in a short period of time, your percentage gain in the call options will be much larger than if you had bought the shares.
• By the same token, if the underlying stock suddenly falls off a cliff, your percentage gain in the put options will be much larger than if you had shorted the shares.

Under normal circumstances, however, few stocks move sharply in the near term. They tread water. They bounce around in a narrow range. Or they trend gently higher or lower.

When you have rare periods of extreme volatility – like the one we’ve experienced over the last three months – options become pricier, making it more difficult to score easy gains.

But the bottom line is this: The overwhelming majority of options expire worthless. Most people trading call and put options lose money.

Why Options Are Riskier Than Stocks

Why are options so much riskier than stocks?

• With stocks, time is your ally.
• With options, time is your enemy.

Built into the price of every option is a time premium. As time passes, that premium diminishes.

To make big money in puts or calls, the stock doesn’t just need to move in the right direction. It needs to make a sharp move in the right direction in a short period of time.

This is no easy trick.

And it’s exactly why selling options – collecting those premiums – is a conservative strategy, while buying options – paying premiums – is an aggressive one.

In the world of options, buyers are gamblers. Sellers are the casino.

Why Investors Continue To Use Option Trading Strategies

If the odds are long against long-term success with buying options, some might ask, why do so many investors continue to use option trading strategies?

Here’s an analogy …

If you’re a decent golfer playing a short par five, you may be tempted to go for the green on your second shot and give yourself a putt for an eagle.

The golf course architect knows this, of course. So what does he do? He puts a pond in front of the green and sand traps on both sides.

The smart thing – the percentage shot – is to just lay-up in front of the water and then chip on for a shot at a birdie.

Yet, often as not, the weekend golfer pulls out his three-wood or long iron and goes for the green. He realizes that his ball will probably end up in the cat box or the drink, but he goes for it anyway.

Why? Because if he pulls it off and makes an eagle, it will be the best thing he did all week. In short, he’s willing to risk it.

If it doesn’t pan out, well, what the heck, he knew the odds when he stepped up to the ball.

I guess what I’m saying is we’re all big boys and girls. Options are a “no-tears” investment. If you don’t understand this, you shouldn’t be trading them.

Puts and calls are neither good nor bad. They are simply tools.

Give a man a chainsaw and he’s likely to do some good work with it. Give it to a six-year-old and someone is likely to lose an arm.

Govern yourself accordingly.

Source: The Truth About Options: Buying Puts & Calls On Stocks

Today, the situation for the VIX is looking quite intriguing. The highly watched index found the momentum to drop below its 50-day moving average. The VIX is currently indicated at 58.93, just below the moving average’s level slightly above the 60 level.

This is only the second time since the end of August the index has traded below its 50-day average. The last time was in late November and the trend lasted for just a few trading sessions. If today’s drop below the resistance level stands up, it will be an indicator of positive action to come.

What does it mean?

As a derivative indicator, the VIX is simply a mirror of what the overall market is doing. By itself, it has no inherent fundamental value. When it declines, it simply tells investors that volatility in the overall market is on the decline.

For average buy-and-hold investors, the VIX has little importance other than telling them the volatile, nausea-inducing ride that is the equities market is beginning to calm. But for options investors, a falling VIX proves that options prices are falling and the spreads between put and call premiums has narrowed significantly. After all, that is what the indicator is designed to tell us.

For the past few weeks, it has been difficult to implement many traditional options plays because implied volatility (the premium added to an options selling price) has been so high. An underlying stock needed to make a sizeable move for the play to pay off. But now that volatility is on the decline, options prices will drop and the profit potential will return. In other words, we can get back to traditional options strategies.

One company worth watching is Arena Pharmaceuticals (NASDAQ:ARNA). In case you missed the news from this $289 million biopharmaceutical this morning, the company just announced clinical testing results for its closely watched obesity-fighting drug, lorcaserin. Of the 469 obese patients in the trial, a statistically significant proportion of them lost more than 5% of their body weight when compared to testers that received a placebo treatment.

While the drug still has a way to go before reaching the market, this is good news for the company in a highly competitive market. So far today, share price has risen by over 10%.

Options investors looking for a trading idea should look at the company’s January 5.00 calls (UGGAA).  Trading for just $0.15, these options have a strong shot at profits as more investors learn of the good news surrounding this company.

As the VIX surpasses its recent lows, more and more options trading opportunities will arise. Keep your eye out for high-potential plays and take advantage of the market’s latest trends.

Source: The VIX declines, Arena Pharmaceuticals (NASDAQ:ARNA) surges

Not every auto manufacturer wants charity, you know.

While Detroit’s CEOs were up on Capitol Hill whining and begging like street junkies for a mere $25 billion to tide them over until spring, salesmen from Bentley, Lamborghini and Maserati were working the floor of the Los Angeles Auto Show like madmen in an attempt to stem their stateside sales losses.

Now don’t let their $500 suits and smooth manners fool you. These guys are hurting too. Lambo’s down 15% (pretty much a match to the whole biz’ 2008 decline). And Volkswagen AG’s Bentley (VLKAY) group has slipped a whopping 30%.

No Pain Here

Perhaps the folks who buy BMWs and Mercedes are up against it right now. But this class is truly different than the rest of us.

While we might go so far as to flaunt a new E-Class as a token of our survival in dark times, to them, it just seems imprudent – or maybe even rude? – to show up at the club in a sparkling new “Azure” or “Reventón,” when the board has just voted to fire the gardener’s assistant. Better to make do with last year’s. After all, it’s not like the leather seats are soiled or such.

Still, despite these losses, these giants of gentility will not beg, not from you and not from Washington either. Aston Martin’s Ulrich Bez has even reputedly been overheard admonishing his people to actively pursue buyers with tales of grandeur (and maybe even hints as to a Vantage’s potential increase in value during these rough times).

The Man Who Saved the Planet

But of one thing you can be sure: the above persuasive admonitions do not come with discounts or “deals” of any sort. Aston Martin may indeed be staring at a 20% shortfall in 2008. But they do not beg.

Speaking of folks who could afford one of Mr. Bez’ prize stallions, those fine folks who own Major League baseball teams have been flying in to New York City for their quarterly confab. Commissioner Bud Selig thought they might be entertained (and possibly informed) by a guest speaker, so he asked his old friend Paul Volcker to stop by.

The once (and perhaps future?) Fed Chairman is a favorite of many of the league’s owners. Tampa Bay Rays owner Stuart Sternberg (who knows Volcker from the days when he was on the board of the American Stock Exchange) has described him as “the man who saved the planet.”

Eight More Years of Drought

Unfortunately, Mr. V. had nothing but dour pronouncements for the group. As Lew Wolff (owner of the Oakland A’s and Chairman of Sunstone Hotel Investors) put it, “He was pretty much alerting us that this is not over yet.”

On second thought, perhaps it is impolitic (or even imprudent) for gentlemen of this high caliber to be seen browsing in the Bentley show room. The League is reputed to have brought down some $6.6 billion in 2008. No on-the-record official, however, wants to guess whether 2009 will be anywhere near as kind.

Now, I am not a member of that rather exclusive club. (At best I occasionally kick in to help fund our local little league franchise.) Nor am I “The Hero of 1979.” But I will gladly hazard a guess as to how long this recession will last: Eight more years.

The Printers’ Devil (Look It Up)

Sound a little draconian? Don’t let it worry you overly much. First off, there’s not a damn thing you can do about it. Secondly, it’s not like the stock market will tank the entire time.

In fact, I do believe that President-elect Obama will be able to re-inflate American blue chip stocks reasonably quickly. He had pretty much promised to print as many dollars as it will take to float the markets, secure the middle class, cure poverty (and cancer too for that matter), and fight a war or three on the side.

The real question won’t be whether this is achievable – with an infinite source of dollars it most certainly is – but whether it is sane.

No, wait, I am wrong.

Ride Both Sides of the See-Saw

Since there appears to be absolutely nothing we can do to stop this juggernaut, perhaps the only real question is: “How do we make so much money off it that they can’t possibly tax and inflate away our whole net worth?”

The answer is smile, nod, appear to be a team player… and play puts and calls on the whole damn mess as the market inevitably twitches and writhes thousands of points each way.

Source: These Upper Crust Automakers Are Too Proud to Beg

Today I think even less of them, as investors have lost billions in these so-called “safe investments” – and many are set to lose more.

Let me briefly explain how structured products work, why so many of them haven’t turned out to be the safe haven investors believed they were, and how you can avoid making a similar mistake in the future…

What Are Structured Products?

Structured products are securities that are sold as an opportunity to enjoy substantial gains with full principal protection.

For example, an underwriter might offer investors the upside potential of the S&P 500 – or a substantial percentage of that upside – over a certain period of time (say, five years) while guaranteeing no less than full value of the initial investment at maturity, even if the index goes down.

(Or, instead of the S&P 500, the investment might be linked to Asian currencies, or commodities, or something else.)

How can you offer all or most of the upside of a risky investment with a principal guarantee? Well, in the early days, Wall Street would take U.S. government zero coupon bonds – which sell at a discount and pay zero interest, but gradually compound in value until they mature at $1,000 – and combine them with index options.

So, for instance, if you invested $100,000 – and investors tended to bet large since their principal was guaranteed by Uncle Sam – $80,000 might go into zero coupon bonds and most of the rest into S&P 500 call options.

Most of the rest? Well, there were Wall Street fees that had to be covered, of course.

Nothing was wrong with these early investments, really. But they were nothing more than a gimmick. You could buy the zero coupon bonds and options yourself and achieve the same thing, saving yourself the fees that Wall Street imposed when it created these products.

Unfortunately, something happened along the way that changed the game completely. Yields on government bonds came down. And the cost of buying index options went up, especially in bull markets.

Yields on U.S. Treasuries just weren’t high enough to make this game work anymore. So instead of investing most of the money in U.S. government bonds, Wall Street firms substituted their own unsecured debt instead. This was disclosed in the prospectus, of course. And it seemed like no big deal as long as these Wall Street giants remained healthy.

But they didn’t.

Structured Products Are An Investor’s Nightmare

Investors who bought structured products from Lehman Brothers, for example, are today standing in line alongside the firm’s other creditors.

These “principal-guaranteed” securities are now selling for 10 cents on the dollar, according to SecondMarket, Inc., a specialist in illiquid assets.

SecondMarket says it has already heard from investors holding more than $2 billion worth of Lehman structured products.

The firm estimates that small investors bought $34 billion of these products through October of this year alone. This surpasses the more than $33.5 billion that were bought last year.

(In truth, of course, these products are sold, not bought. No one wakes up and says “I think I’ll invest in a structured investment product today.”)

Last week The Wall Street Journal told the story of Charles Brooks, a physician in Allentown, PA:

• He put a significant sum in two Lehman structured products because he liked the idea of having some exposure to market gains along with protection from losses.
• Today he says these “protected” assets are worth approximately seven cents on the dollar. Sixty-five years old, he is now delaying his retirement planning.
• And he is angry at Wall Street. “There’s no end to things they can invent that seem to me little more than a gamble for the enjoyment of the inventors,” he says.

I don’t fault Dr. Brooks for believing that a note guaranteed by Lehman Brothers was pretty safe. Ninety-nine percent of investors would have made the same assumption 12 months ago.

Structured Products Are A Wall Street Gimmick

The shame, really, is that by buying these structured products, he was sold a Wall Street gimmick. There is nothing magical about these products that offer huge upside potential with a principal guarantee.

After all, I could take $100,000 from you, put the vast majority of it in U.S. government zero coupon bonds and use the balance to play roulette at the Bellagio for five years. If I win, you would get back a lot more than $100,000.

And if I lost everything, which of course I would, I could still guarantee the full return of your hundred grand when bonds mature.

Like I said, gimmick.

There are two lessons here for every investor:

• The first is as old as investing itself: If it sounds too good to be true, it probably is.
• Number two, however, is just as important. Whenever you hear that an investment, an insurance policy, an interest payment, a stock dividend, or a particular return is guaranteed, be sure to ask the next question: By whom?

Source:  Structured Products: Another “Safe Investment” Bites the Dust

This from The Smart Profits Report:

Believe me, there are times I’m sure the last thing you want to hear about is the stock market. Sometimes, that’s true for me, too! And I understand that with each day that your portfolio losses grow, that’s when panic and/or depression sets in. When I was a rookie investor, I felt that way, because I didn’t think there was anything I could do.

But take it from me: At times like this, you must avoid panicking at all costs.

The thing is, markets are not one-way streets. And although it’s tough to argue that fact when we’re in a midst of an extreme correction that can only be compared to a 100-year flood, events like this can happen and we simply have to deal with it.

So this is not the time for a pity party or complaining. Here’s why…

Picking Through The Rubble For Strength And Extreme Value

While the stock market looks like a tornado has whipped through it over the past few months, lurking in the rubble are companies trading at valuations we haven’t seen for decades.

What’s more, they’re good, solid companies. True survivors that will allow you to recoup your losses as the market bounces back. And while it’s important to note that this may take some time, if you don’t have a horse in the race, you have no chance of winning, or even placing.

So where does that leave investors like you and me? What’s the best way forward?

An Investor’s Best Friend

Over the past few months, one investment strategy has risen to the top of the pack.

In fact, people whom I never thought would embrace it are now raving about its benefits. But understand that this is a strategy for those who can look beyond the hype and promise of home run, triple-digit return promises and instead towards something that many investors crave right now: Steady, consistent income.

And it’s a strategy that has taught me that there are ways to benefit from volatile and even falling markets – perfect for the current climate.

I’m referring to covered call investing.

In a nutshell, the strategy has two parts…

1. You buy shares of a company.
2. You sell call options against your shares.

What does this accomplish? First, it allows you to reduce your basis in the share price by collecting a special “dividend” (known as a premium) from the proceeds of the options that you sold.

In a flat or range bound market, you can do this over and over again, consistently reducing your original cost and setting yourself up for big returns in the future. Here’s how it works…

The Breakdown Of A Covered Call Trade

Let’s say you like General Electric (NYSE: GE).

You buy shares of GE at the current price around $17.

Against this position you sell GE $20 call options that expire in January 2009.

What this means is that you’re obligated to sell your GE in January at $20 if – and only if – the share price is over $20 at the time. If not, you keep your GE shares and any proceeds you received for selling the option.

If GE closes below $20 at expiration in January, you can sell another option and collect more money and continue to lower your cost. The caveat here is that if GE closes above $20, you still only get $20. The loss of the upside is the price you pay for the safety of lowering your downside.

The money you receive for selling the option(s) is called the premium. For example, if GE January $20 options are trading for $1, you will receive $1 for each share that you own and have sold an option against it.

Remember, options trade in contracts, with each contract equal to 100 shares. So if you own 100 shares of GE, you can sell one call option contracts. At $1 per contract, you will receive $100 – 1 contract x 100 shares per contract x $1.

So let’s say you sell just one call option against your 100 shares. With the $1 premium, your cost in GE is now $16 and your upside is $4 – the difference between the strike price and your cost. The extra dollar you picked up is like an extra 6% dividend ($1 divided by $16 (your cost).

But I like to put my own twist on this. It’s not exactly the conventional way of covered call investing – but it’s a big reason why my Strategic Income service has managed to notch up a 70% win rate over the past 11 years. Here’s what I do…

An Even Better Way To Trade Covered Calls

Instead of selling a call option above the price at which you buy the underlying shares, you sell it below that price.

My rationale is this: We’re essentially saying to the market that we want to own GE shares… but we want to own them at a lower price. Our price. Here’s how it works.

~ We buy GE at $17

~ We then sell the January 2009 $15 calls against the position.

For doing so, we’ll automatically get $2 back – known as the “intrinsic value” ($17 minus $15.) But we’ll get more.

For time and risk, we’ll pick up an extra $1 to make the total premium $3 ($2 intrinsic plus $1 for time and risk). That lowers our original cost in GE to $14.

So we stand to make $1 profit on the trade, as long as GE closes above $15 in January. If this happens, our return is about 7% in a couple of months – a full $2 below the current price.

You see how this works? We’re not betting that the shares are going higher… we’re actually saying that if they go nowhere or even lower, we still stand to make money as long as the shares are above our cost of $14 ($17 purchase price minus $3 premium received).

Three Chances To Win In A Market Like This? I’ll Take It!

The bottom line here is that we have three chances to win…

1. If GE shares rise, we win.
2. If GE remains flat, we win.
3. If GE shares fall – but not under $14 – we win.

I don’t know about you, but I like those odds – especially in a market like this.

But what happens if GE slides under $14?

Well, since our cost was lower than the $17 we paid for the shares, there is an excellent chance that we’ll be able to sell more options and reduce our cost even further, while increasing our upside potential.

Source: The Best Investment Strategy For A Market Like This… The Truth About Covered Call Investing