Ideas For Smart Selling In An Uncertain Stock Market

Includes: CAT, CVX, MMM, MO, MSFT, NEM
by: Marc Courtenay

You don't have to be a visionary to be pessimistic in the current bombardment of negative headlines and economic uncertainty.

Yet even if you're reading "between the headlines" and you're optimistic, one has to admit that it's getting gloomier at a time of the year that usually brings financial good cheer.

Today's gloomy "soup-of-the-day" came from the French managing director of the International Monetary Fund.

She told the world that the European debt crisis is growing to the point that it won’t be solved by one group of countries. Then came the really frightening punchline.

Madame Lagarde said that if countries don’t work together, the world will face a situation similar to the 1930s (think "Great Depression), before the world slid into World War II.

“There is no economy in the world, whether low-income countries, emerging markets, middle-income countries or super- advanced economies that will be immune to the crisis that we see not only unfolding, but escalating at a point where everybody would actually have to focus on what it can do,” Lagarde said.

This is the kind of scare tactics that I can really sink my teeth into. It seems purposely designed to justify the current market slump and drastic slide in precious metals prices.

How to Sell "Smart" in the Face of Gloom

One of the ways is to sell put options. You'll have to meet certain qualifications with your brokerage firm, and you'll have to understand the risks associated with selling options.

Don't sell more contracts then the number of shares of the underlying stock that you're willing to own.

The classic example would be that you'd like to own 100 shares of Newmont Mining (NYSE:NEM) at $55-per-share. It's currently trading around $62.

You could sell, as of Thursday (12/15/11) one June 2012 $55 strike price put option contract for around $3.45. Since each contract represents 100 shares of the underlying stock you'd be paid $345 ($3.45 X 100).

This gives the buyer the right to sell you 100 shares of NEM at $55 if the price is at that level or lower between now and the third Friday in June 2012.

If the stock were to move back to recent highs, like the December 1st intraday price of $69.40, you could theoretically buy-to-cover the same contract at a much lower price and pocket the difference.

The risk would be if NEM dropped way below $55 and you were forced to buy it at that price by option expiration date.

But when you factor in the $345 you were paid when you sold the put that lowers your buy price down to around $51.55 per share (assuming you bought at $55).

So the stock would have to close below $51.55 on option expiration day for you to end up loosing money by having to buy the 100 shares of NEM above that price.

If you hold the NEM put option till expiration and it closes at $55 or higher, you get to pocket the entire $345 as profit.

Its like being paid to wait for NEM to drop to or near the price that you'd like to buy it.

Another example would be Chevron (NYSE:CVX), currently trading at about $100-per-share. You'd like to buy 100 shares at around $90 and get paid to wait.

What you can do is sell a March 2012 put contract with a $90 strike price at $3.05. You'd be paid $305 ($3.05 X 100).

CVX would have to fall 10% from its current price and stay there (or fall lower) by expiration date (March 17,2012) for you to be forced to buy 100 shares at $90.

If CVX rallies in the near term you can buy-to-cover that option contract and keep the difference.

If it keeps falling, but you believe it won't fall much farther than the November 25th, 2011 intraday low of $92.29, you could place an order to buy 100 shares if it reaches that price.

Hopefully well before March 17, 2012 the stock will rally higher, and if it doesn't close below $90 on that date and you are still holding the now-expired put contract, you've lowered your cost-per-share purchase price to $89.24 ($92.29-$3.05).

There are other stocks like Altria (NYSE:MO), Caterpillar (NYSE:CAT), Microsoft (NASDAQ:MSFT) and 3M (NYSE:MMM) where selling a put option with a strike price close to where you want to own the shares of stock may make sense.

Speak to an options specialist at your brokerage firm for other selling strategies.

Ask them to introduce you to one of the most conservative ones referred to as "selling covered calls" (aka "writing covered calls") on the shares you own.

You can go online and check the "option chain" on a stock you're interested in owning, or ask a representative at your brokerage firm to explain how to use their "option chain" to get ideas and quotes.

Waiting to Sell as the Current Market Patterns Continue

The last 5 months we've seen the repetitive up-and-down pattern in the stock market that allows short-term traders to "buy the dips" and then "sell the bounces".

There are some reliable and independent analysts who believe that stock prices could double from current levels based on a little understood factor called "earnings yield."

A full discussion of this topic is beyond the scope of this article, but suffice it to say that the earnings yield on stocks is now around 8.3%.

Meanwhile, corporate bonds are paying around 5%. Ten-year Treasury Bonds are paying less than 2%.

This is a unique, first-time-ever extreme in favor of stocks. Put another way, the earnings yield on stocks is at the highest premium over corporate bond yields since the last Great Bull Market in stocks began back in 1980.

At some point this disparity will be corrected and stock prices will begin to ascend sharply.

That's because "earnings yield" has to do with how our money achieves better returns and get "treated better".

Money invested in stocks is getting treated better right now than in any other investment class.

The earnings yield is historically way too high to ignore. Money inevitably flows to where it's treated best. At current pricing that is the stock market.

Sell Till You Reach Your Optimum "Sleeping Comfortably" Level

Current investment market conditions are unnerving, unless you own Treasury Bonds that you purchased when interest rates were higher, or you're mostly in cash.

If you're leveraged in the stock or commodities markets, consider reducing your levels of risk.

If nothing else, "lighten up" in case the worst-case-scenario plays out. You'll need all the cash you have just to live on and to buy at the bottom, and you may sleep better now.

When it comes to selling at this point, remember what you've learned from similar past economic and market conditions.

Having been through horrible markets like Nov. 2008 through March 2010, I know how gut-wrenching this all can be.

Before you sell good quality, low-priced stocks at these levels, ask yourself a number of rational questions.

One question may be, "Are the Central Banks and the Politicians going to let us slip into a Great Depression?"

Are they going to sit on their hands and do nothing? I tend to agree with the recent reflections on this topic by billionaire investor John Embry.

People are now fussing about deflation and Europe is going to go down. If you actually think about that for more than two minutes, you realize it’s just going to lead to massive amounts of papering over because there is no other alternative.

They [central planners] are not going to voluntarily accept a 1930s style deflationary collapse of the economy. The only antidote to that is immense amounts of money creation, and that’s what’s going to happen.

At that point the money-mavens start reflating the money supply, and that usually leads to higher prices for precious metals (gold, silver, platinum) and stocks.

It may get worse before it gets better, but history, the "earnings yield", and the need for drastic monetary action is on the investors' side.

If the markets and commodities dip lower, consider selling those holdings that are still well above your buying price and buy whatever becomes greatly undervalued.

When the next multi-week reactionary rally does begin you should have plenty of opportunity to sell into strength, capture gains, and buy-to-cover anything you've sold short.

That's why now is high time to be both a "smart seller" and a "clever buyer".

Disclosure: I am long CVX, CAT, MSFT, MMM.

Additional disclosure: I am initiate a position (or sell a put option contract) in NEM.