10 Income Ideas for a Down Market

by: Parsimony Investment Research

The U.S. economy continues to have significant headwinds (e.g., high unemployment, end of QE2, weak housing market, high debt levels, etc.) and signs are definitely pointing toward further weakness in the equity market. As such, it is getting harder and harder for investors to put new money to work in the current market environment.

That said, we think that selling cash-secured puts is a perfect strategy for an income investor in a down market. It allows investors to generate income while mitigating downside price risk.

Put Selling Strategy
If you sell a put, you have an obligation to purchase the stock at a predetermined price (strike price) on or before the expiration date (if the buyer of the put option wants to sell you the stock). Clearly, the risk is that the stock drops significantly below the strike and you are forced to buy the stock at a price above market.
Below are our two risk management rules of put selling:
  1. Only sell put options on stocks that you want to own at the price you want to own them. With a put selling income strategy (focused on out-of-the-money puts), you get paid to wait for the price you want on a stock. If the price never drops to your strike, you get to keep the premium (income) as a consolation prize. Your downside is owning the stock at the strike price (keep that in mind as you analyze the ideas below).
  2. Don't sell "naked." Just because options offer you leverage, it doesn't mean that you have to use the leverage. We recommend securing your short put position with cash (i.e., don't sell on margin). If you aren't willing to risk the cash to back it up ... don't sell the put.

The table below highlights specific recommendations for an investor implementing a put selling strategy. On average, these positions have a seven-month yield potential of 7.7% (13.2% annualized) with a margin of safety of 16.6%.

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We feel that this strategy is a great way to generate income in a down market -- especially since the downside is owning a great company at a great price.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.