MILESCFA

Readers Pick the Top 20 5-Year Horizon Stocks

That was an interesting popularity contest. However, we're in a secular bear market that is undergoing a strong (counter-trend) cyclical bull. I would not want to be initiating a 5 yr "buy and hold" here and my one instablog shows why :

seekingalpha.com/user/...

I urge you to at least view the first chart in my instablog, which is a 90 yr Dow chart showing percentage ups and downs. Volatility rules in a secular bear
...

Hedge Fund Liquidations Bear Some Blame For Market Drop

"selling covered calls is a sucker bet"

... only if you're a sucker, ie you're selling out-of-the-money calls. This is how you "give up your big winners and keep the losers."

I'm sure this fund is very professionally managed and in today's high volatility environment, option premiums are very high (ie, expensive). Do you want to be a buyer of "pricey" assets or the seller?

So here's the non-sucker strategy: You sell "reasonably" deep-in-the-money calls against the stock owned. The point is, YOU WANT TO HAVE EVERY STOCK CALLED AWAY. This can be a very lucrative strategy because you're collecting the time premium embedded in the option.

Take AAPL for example. Today's close (10/13) was $110.26. If you sold the Nov 08 $90 call at the BID of $25, you're essentially selling for $115 in 38 days. $115/110.26=1.043, or 4.3% OVER 38 DAYS. 1.043^(365/38) = 1.498, or 49.8% annuallized.

I'd take a 49.8% annualized return, would you?

MORE: How did I choose the 90 strike price? It was somewhat arbitrary, in that AAPL "bounced" off support at $90. However, this is a good "rules-based" choice too. Why? You need to be knowledgeable on options, but the 90 strike has a "delta" of around 0.8, or commonly "80". This "means" the option should experience 80% of the upside move of the stock but also only experience 80% of the downside move (note: Delta's change).

Another useful feature of "delta" is that it approximates the likelyhood of the option finishing "in the money", which in our case is what we want. So let's say we always sell covered calls at "80" deltas. If statistics hold, our return would be close to 80% of 49.8%, or 40%, STILL A FANTASTIC ANNUAL RETURN.

And by the way, we don't lose on AAPL until it drops below $85.26 [$90 strike - the time premium we collect, aka ($115-$110.26)]. What is the chance of AAPL dropping from our buy point of $110.26 to our break even of $85.26 in 38 days. Well, this is the same as asking what's the probability of AAPL dropping 22.7% in 38 days? In a sense, it's a trick question. We already know there's an about 80% chance of us breaking even (ok, going to $90, but the point is the same). In this market, it feels like there's a 100% chance of AAPL dropping to $85, but the key point is this - since volatility is high, the option premium is high, so you're being paid for taking this chance, and the pay can be handsome.

Who's the sucker? (Answer: the one NOT making 40% annualized)
**********************...
As for the article, it makes some excellent points. I do think that hedge fund selling has been a big factor, but I also think it feed into the classical fear selling by longs [ the gov "outlawed" shorting, right! :-) ]. And teh arthor did not even mention the $2 dividend historically paid.

The only real question is do you want to be (or have to be) in the market over the next 2 years? We're in a bear market and if it's over, I'd be surprised. Still, it looks like an attractive place to hide and/or play for a bear market rally...

.. whoops. It's been 36 hours since the author bought. Look's like we've already had the rally ;-) .