Friday, November 19, 2010

Income investing in volatile markets

How should an income investor invest when the markets are all over the place as we have seen recently?

Three strategies: (1) have your wish list ready, (2) know which stocks are at highs and consider stops or write calls, (3) for sophisticated investors you could consider buying put options to protect your downside.

When the market corrects you should be ready to buy stock. Do your research ahead of time. I keep a list of about 30 stocks that  meet all my criteria but may be a little more expensive than I want to pay. Sometimes, they go down with a general market correction. Check the news on these companies to make sure no major issues like the BP oil well fiasco is the reason your stock is on sale. If you are still happy with your selection, buying when the market is down is a good idea.

When the market is at its high, know which of your holdings are at all time highs. Some stocks will continue to go higher but you may feel you want to lock in the gains. How often have I heard an investor wish they had taken profit? I do not recommend a lot of trading as you know, but I am also not afraid to set a stop which means I tell the broker to sell the stock if it goes down by 10%. This move has protected me on several, but not all occasions.

Another technique when the market is high or when you have an individual stock that is at the high is to write covered calls. If the stock is high, someone out there will think it is going higher and will pay you money in a covered call. You obviously already have a gain in the stock so creating additional income by selling a covered call is a good move. If you lose the stock to the option buyer that is o.k. you have the gain and the covered call income, plus if you selected wisely, you probably also have at least one dividend.

The last technique for the more sophisticated investor is to buy a put option. You pay someone to buy the stock from you at a price of lets say 10% below the high. If you do not want to sell it you do not have to, but if the stock is volatile and you are afraid it may weaken a lot, then buying a put means another person has to buy it from you at the strike price. This is referred to as "putting it to them."

Very Truly Yours,